Federal Register / Vol. 63, No. 15 / Friday, January 23, 1998 / Notices 3601

24 15 U.S.C. § 78s(b)(2).

25 17 CFR 200.30–3(a)(12).

1 15 U.S.C. 78s(b)(1).

2 17 CFR 240.19b–4.

3See Securities Exchange Act Release No. 37691

(September 17, 1996), 61 FR 50060.

4 In Amendment No. 1 to its proposed rule

change, the Phlx restated the original proposal and

proposed several changes as set forth in detail in

Section III of this release.

5See Securities Exchange Act Release No. 38519

(April 17, 1997), 62 FR 20048.

6 In Amendment No. 2, the Exchange amended

the Request for Quote process to require a

Requesting Member to indicate the size of an order

and the intention to cross, if applicable. In addition,

the Phlx proposes specific position limits of 22,000

contracts for Super Cap Index options. See Letter

from Edith Hallahan, Director and Special Counsel,

Regulatory Services, Phlx, to Sharon Lawson,

Senior Special Counsel, Office of Market

Supervision (‘‘OMS’’), Division of Market

Regulation (‘‘Market Regulation’’), Commission,

dated June 25, 1997 (‘‘Amendment No. 2’’).

7See Letter from Theresa McCloskey, Vice

President, Phlx, to Sharon Lawson, Senior Special

Counsel, OMS, Market Regulation, Commission,

dated August 26, 1997 (‘‘Amendment No. 3’’).

8The Phlx replaces Amendment No. 3, in its

entirety, with Amendment No. 4, and proposes to:

(1) eliminate the application of position and

exercise limits to FLEX equity options; (2) reduce

the minimum size applicable to a Request-for-Quote

for a closing transaction in already-opened FLEX

equity options from 100 to 25 contracts; (3) clarify

the parity and priority principles for FLEX options

transactions; (4) amend the proposed rule change to

refer consistently to ‘‘FLEX index and equity

options’’ (as opposed to index FLEX options); (5)

correct the text of proposed Rule 1079(b)(6)

regarding the crossing procedure to reflect that the

crossing intention has already been announced as

part of the RFQ, as amended by Amendment No.

2; and (6) amend proposed Rule 1079(a)(1) to

clearly state that any options-eligible security

pursuant to Rule 1009 is eligible to underlie FLEX

equity options trading and any index underlying

Non-FLEX options trading is also eligible for FLEX

index options trading. These proposed changes are

described more fully herein. See Letter from Philip

H. Becker, Senior Vice President, General Counsel

and Chief Regulatory Officer, Phlx, to Sharon

Lawson, Senior Special Counsel, OMS, Market

Regulation, Commission, dated November 3, 1997.

9The Phlx proposes in Amendment No. 5 to

replace section 3 of Amendment No. 4 and

withdraw the examples provided in Amendment 4.

In Amendment No. 5, the Phlx clarifies: (1) the

parity and priority principles for FLEX options

transactions; and (2) that each assigned ROT or

assigned Specialist is not required to respond with

a quote in every instance, unless requested by a

Floor Official. See Letter from Michele R.

Weisbaum, Vice President and Associate General

Counsel, Phlx, to Sharon Lawson, Senior Special

Counsel, OMS, Market Regulation, Commission,

dated December 9, 1997 (‘‘Amendment No. 5’’).

consistent with Section 6(b)(5) of the

Act to approve Amendment No. 2 to the

proposed rule change on an accelerated

basis.

IV. Solicitation of Comments

Interested persons are invited to

submit written data, views and

arguments concerning Amendment No.

2 to the proposed rule change. 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

rules changes that are filed with the

Commission, and all written

communications relating to Amendment

No. 2 between the Commission and any

persons, 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 at the

principal office of the Exchange. All

submissions should refer to File No.

SR–Phlx–97–23 and should be

submitted by February 13, 1998.

V. Conclusion

It is therefore ordered, pursuant to

Section 19(b)(2) of the Act,24 that the

proposed rule change (SR–Phlx–97–23),

as amended, is approved.

For the Commission, by the Division of

Market Regulation, pursuant to delegated

authority.25

Jonathan G. Katz,

Secretary.

[FR Doc. 98–1551 Filed 1–22–98; 8:45 am]

BILLING CODE 8010–01–M

SECURITIES AND EXCHANGE

COMMISSION

[Release No. 34–39549; File No. SR–Phlx–

96–38]

Self-Regulatory Organizations; Order

Approving Proposed Rule Change and

Notice of Filing and Order Granting

Accelerated Approval of Amendment

Nos. 2, 4 and 5 to the Proposed Rule

Change by the Philadelphia Stock

Exchange, Inc., Relating to the Listing

of Flexible Exchange Traded Equity

and Index Options

January 14, 1998.

I. Introduction

On August 21, 1996, the Philadelphia

Stock Exchange, Inc. (‘‘Phlx’’ or

‘‘Exchange’’) filed a proposed rule

change with the Securities and

Exchange Commission (‘‘SEC’’ or

‘‘Commission’’), pursuant to Section

19(b)(1) of the Securities Exchange Act

of 1934 (‘‘Act’’) 1 and Rule 19b–4

thereunder,2 to provide for the listing

and trading of Flexible Exchange

Options (‘‘FLEX options’’) on specified

indexes (‘‘FLEX index options’’) and

equity securities (‘‘FLEX equity

options’’).

Notice of the proposal was published

for comment and appeared in the

Federal Register on September 24,

1996.3 The Phlx submitted to the

Commission Amendment No. 1 to its

proposal on March 6, 1997.4 Notice of

Amendment No. 1 was published for

comment and appeared in the Federal

Register on April 24, 1997.5 The Phlx

submitted to the Commission

Amendment No. 2 to its proposal on

July 1, 1997.6 The Phlx submitted

Amendment No. 3, on August 27, 1997,7

which was subsequently replaced in its

entirety by Amendment No. 4, which

the Phlx submitted to the Commission

on November 7, 1997.8

The Phlx submitted Amendment No.

5 to the Commission on January 6,

1998.9

No comment letters were received on

the proposed rule change or on

Amendment No. 1 to the proposed rule

change. This order approves the

Exchange’s proposal, as amended by

Amendment Nos. 1 through 5.

II. Background

The purpose of the Exchange’s

proposal is to provide a framework for

the Exchange to list and trade equity

and index options that give investors

the ability, within specified limits, to

designate certain of the terms of the

options. In recent years, an over-thecounter (‘‘OTC’’) market in customized

options has developed which permits

participants to designate the basic terms

of the options, including size, term to

expiration, exercise style, exercise price,

and exercise settlement value, in order

to meet their individual investment

needs. Participants in this OTC market

are typically institutional investors, who

buy and sell options in large-size

transactions through a relatively small

number of securities dealers. To

compete with this growing OTC market

in customized options, the Exchange
3602 Federal Register / Vol. 63, No. 15 / Friday, January 23, 1998 / Notices

10See Phlx Rule 1079.

11For 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.

12The Exchange believes that the flexible exercise

price feature could result in an available call option

that would not be eligible to be a qualified covered

call (‘‘QCC’’) under Section 1092(c)(4) of the

Internal Revenue Code, thus jeopardizing a modest

tax benefit currently enjoyed by writers of

standardized non-FLEX equity call options.

Accordingly, the Phlx’s rules will restrict exercise

prices for FLEX equity call options. See also

Securities Exchange Act Release No. 37726

(September 25, 1996) (File No. SR–Amex–96–29;

SR–CBOE–96–56; and SR–PSE–96–31).

13An American-style equity option is one that

may be exercised at any time on or before the

expiration date.

14A European-style equity option is one that may

be exercised only during a limited period of time

prior to expiration of the option.

15The proposal, however, requires that the

expiration date of a FLEX equity option may not fall

on a day that is on, or within two business days

of the expiration date of a Non-FLEX equity option.

In addition, FLEX index options must have an

expiration date within 5 years of issuance, and

FLEX equity options within 3 years of issuance.

16Securities Exchange Act Release No. 34925

(November 1, 1994) (SR–Phlx–94–18).

17See, e.g., CBOE Rules 24A.1–24A.17; Amex

Rules 900G, et. seq.; and PSE Rules 8.100–8.115.

18FLEX index options and FLEX equity options

have been deemed ‘‘standardized options’’ for

purposes of the Rule 9b–1 options disclosure

framework. See e.g., Securities Exchange Act

Release Nos. 31920 (February 24, 1993) (Order

approving FLEX options based on the S&P 100 and

500 Indexes); 31910 (February 23, 1993) (FLEX

index option 9b–1 order); and 36841 (February 14,

1996) (Order approving FLEX equity options for

CBOE and PCX, and designating FLEX equity

options, and FLEX index options traded and settled

in certain designated foreign currencies, as

‘‘standardized options’’). See also Securities

Exchange Act Release No. 37824 (October 15, 1996)

(FLEX equity option 9b–1 order).

19The original proposal was published for

comment in Securities Exchange Act Release No.

37691 (September 17, 1996) (File No. SR–Phlx–96–

38).

20The term ‘‘FLEX’’ is a trademark of the Chicago

Board Options Exchange, Inc. (‘‘CBOE’’).

21The 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

(‘‘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

or an 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. In addition, the Exchange

proposes to delete the provision that requires

approval by the Options Committee prior to listing

an otherwise eligible FLEX product. See

Amendment No. 4, supra note 8.

22See Phlx Rules 1000, et. seq.

23The Exchange represents that Rule 1079

generally parallels the provisions of Rule 1069

governing customized foreign currency options.

24 Initially, the exercise strike price will not be

available for customization as a percentage, pending

systems enhancements.

25See Rule 1012, Commentary .05.

26An 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).

27 In certain circumstances, European style FLEX

equity options may be adjusted to require the

delivery upon exercise of a fixed amount of cash.

See OCC By-Law, Article VI, Section 11,

Interpretation and Policy. 08.

proposes to adopt rules 10 to permit the

introduction of trading in FLEX options

in an exchange auction market

environment, with The Options Clearing

Corporation (‘‘OCC’’) as issuer and

guarantor.11 Thus, FLEX options are

structured with a minimum size

reflecting the larger-sized trades of these

institutional users. The Exchange’s

proposal will allow FLEX option market

participants to designate the following

contract terms: (1) exercise price (except

for certain limitations for FLEX equity

call options); 12 (2) exercise style (i.e.,

American 13 or European,14; (3)

expiration date; 15 (4) option type (put,

call, or hedge order); and (5) form of

settlement (for index options—A.M.,

P.M. or average).

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, 1994.16

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.17

OCC will be the issuer and guarantor

of all FLEX index and equity options.

Similarly, the Commission has

previously, designated FLEX index and

equity options as standardized options

for purposes of the options disclosure

framework established under Rule 9b–1

of the Act.18

III. Description of the Proposal19

The Phlx proposes to adopt Rule

1079, FLEXTM index and equity20

options, which would govern the

trading of FLEX index and equity

options on the Exchange. The Exchange

proposes to designate all Phlx index

options as eligible for FLEX options

trading.21 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

FLEX equity options on securities

which are options-eligible pursuant to

Rule 1009.

Proposed Rule 1079 contains the

characteristics, trading procedure and

other provisions applicable to trading

FLEX 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,22 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 preestablished, 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).23 For

example, the exercise strike price

respecting FLEX index 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).24

Similarly, respecting FLEX equity

options, the exercise strike price can be

specified in terms of a specific dollar

amount rounded to the nearest oneeighth 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 FLEX

equity 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 standardized non-FLEX

equity options.25

The exercise style can be either

American or European,26 regardless of

the exercise style of the listed option.27

The expiration date can also be

customized, specifying any business day

(non-holiday)—any month, day and year

within five years for Flex index options

and three years for FLEX equity options.
Federal Register / Vol. 63, No. 15 / Friday, January 23, 1998 / Notices 3603

28Quarterly expiring index options expire on the

first business day of the month following the end

of the calendar quarter.

29This 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.

30The Exchange originally proposed minimum

closing (if there is open interest) and responsive

transaction sizes of 100 contracts. See Amendment

No. 4, supra note 8.

31See, e.g., Securities Exchange Act Release No.

38839 (July 15, 1997), 62 FR 39040 (July 21, 1997)

(order approving File No. SR–CBOE–97–10).

32The 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 15, 1997) (SR–Phlx–96–36).

33This 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.

34OCC 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.

35See Rules 1000(b)(7) and 1066(f).

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 nonFLEX option on the same underlying

index or security (other than a quarterly

expiring index option). 28 In addition, a

FLEX option cannot expire on the same

day that series is established at OCC.29

With respect to the minimum size of

FLEX market index 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 for an opening or closing

transaction 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 a FLEX index option (index

multiplier times the current index

value) multiplied by the number of

FLEX index options. The minimum

value size for a responsive quote in

FLEX market index 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

FLEX industry index 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 onehalf of the minimum size proposed by

the Phlx and currently in place on other

options exchanges for flexible broadbased index options. Where there is

open interest, the minimum value size

of an RFQ for an opening or closing

transaction 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

FLEX equity 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 in the case of an opening

transaction; and 25 contracts, or the

remaining size on a closing transaction,

whichever is less. The minimum value

size for a responsive quote in FLEX

equity options is 25 contracts, or the

remaining size on a closing transaction,

whichever is less.30 The Phlx also

proposes that the minimum size for

FLEX equity options exercises is

reduced from the originally proposed

100 contracts to 25 contracts.

The Exchange proposes to lower the

minimum size from 100 to 25 contracts

under such circumstances, in part, to

conform to the rules of other options

exchanges.31 Further, the Exchange

believes that the ability to close

positions in increments smaller than

100 contracts should attract additional

FLEX trading interest. The Exchange

notes that market participants wanting

to execute an opening transaction in a

particular series of FLEX equity options

will continue to be required to meet the

250 or 100 minimum contract

requirement.

Assigned ROTs and assigned

Specialists, who respond to an RFQ, are

required to respond to each RFQ with a

certain minimum size. Respecting FLEX

market index options, assigned ROTs

and assigned Specialist, who respond to

an RFQ, are required to respond with at

least $10 million underlying equivalent

value or the dollar amount requested in

the RFQ, whichever is less. Respecting

FLEX industry index options, assigned

ROTs and assigned Specialists, who

respond to an RFQ, 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 FLEX

equity options, assigned ROTs and

assigned Specialist, who respond to an

RFQ, are required to respond with a

market of at least 250 contracts or the

size amount requested in the RFQ,

whichever is less.

The settlement value for FLEX index

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.32 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 FLEX

index options exercised prior to the

expiration date can only settle based on

the closing value on the exercise date.33

FLEX index options maybe 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 FLEX equity

options, exercise settlement shall be by

physical delivery of the underlying

security pursuant to Rule 1044. Also,

FLEX equity options will be subject to

the exercise-by-exception procedures of

OCC.34

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.35

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 announced 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 FLEX index

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
3604 Federal Register / Vol. 63, No. 15 / Friday, January 23, 1998 / Notices

36Operationally, the Requesting Member

provides this information to data entry personnel,

who enter it into Exchange systems.

37See Amendment No. 2, supra note 6, and

Amendment No. 4, supra note 8.

38 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. See also CBOE Rule

24A.4(a)(3)(iii).

39 In Amendment No. 5, the Phlx states that

assigned Specialist and Assigned ROTs generally

should not receive priority over customer orders in

FLEX options transactions, because of their duty

under the Act and Exchange rules to assist in the

maintenance of a fair and orderly market by

responding to temporary disparities between supply

and demand, a lack of price continuity or a

temporary distortion in pricing relationships. See

Amendment No. 5, supra note 9.

40Thus, 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 seek to

sell 500 contracts at 6, the Requesting Member has

priority for that purpose.

Member shall cause the terms of the

RFQ to be disseminated as an

administrative text message through the

Options Price Reporting Authority

(‘‘OPRA’’).36 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 RFQ.37

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.38 During the

response time, qualified members may

provide responsive quotes to the RFQ,

which may be entered, modified or

withdrawn during such response time.

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, proposed Phlx Rule

1079(b)(3) states that bids/offers

submitted by an assigned Specialist,

assigned ROT or customer will have

priority over the bids/offers submitted

by non-assigned ROTs and by controlled

accounts as defined in Phlx Rule

1014(g)(i).39 The Exchange has also

explicitly set forth in the text of the

proposed rule and Advice F–28 stating

that all transactions must be in

compliance with Section 11 of the Act

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. 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

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.40 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, the RFQ

remains open that trading day, unless a

trade occurs, and a member may requote 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.

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 FLEX index or

FLEX equity 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. The Requesting

Member must voice the crossing

intention as part of voicing the RFQ.

With respect to FLEX options, after the

BBO has determined, the Requesting

Member intending to cross must bid (or

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 the 25%

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.

Broker-dealer crosses and solicited

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. 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
Federal Register / Vol. 63, No. 15 / Friday, January 23, 1998 / Notices 3605

41However, assigned ROTs and assigned

Specialists are not required to provide continuous

quotes or markets at a certain minimum bid-ask

differential (quote spread parameter).

42However, 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.

43The 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 Rule 19b–4 filing with the Commission

proposing appropriate FLEX market index options

position limits.

44The 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’’), Utility Index (‘‘UTY’’), Forester and Paper

(‘‘FPP’’), Plane (‘‘PLN’’), Phone (‘‘PNX’’), and Oil

Service (‘‘OSX’’). Because the Super Cap Index

(‘‘HFX’’) is neither a market or 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). See Amendment No. 2,

supra note 6.

45See e.g., CBOE Rule 24A.7(b).

46See 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.

47See Amendment No. 4., supra note 8. The

Exchange originally proposed position limits of

three times the position limit applicable to nonFLEX equity options, pursuant to Rule 1001. The

Phlx will provide the Commission with status

report after one-and-a-half years of the pilot for the

Commission to assess the effects on the markets of

the elimination of position and exercise limits on

FLEX equity options.

48See Securities Exchange Act Release No. 39032

(September 9, 1997) (File Nos. SR–Amex–96–19;

SR–CBOE–96–79; SR–PCX–97–09) (‘‘FLEX Equity

Option Position Limit Approval Order’’).

49The Commission notes that issuers would, of

course, need to comply with all applicable

provisions of the federal securities laws in

conducting their share repurchase programs.

remainder (75%) to assigned ROTs/

Specialists.

The Exchange notes that an ROT and

Specialist may trade FLEX options as an

assigned ROT/Specialist or as a nonassigned 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, as noted above, assigned ROTs

and the assigned Specialist, who

respond to an RFQ, are required to

respond with a market of the minimum

size.41 At least two Exchange members

(ROTs and/or a Specialist) shall be

assigned to each FLEX option. If there

is an assigned Specialist and an

assigned ROT, 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.

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.

Generally, FLEX option positions are

not taken into account when calculating

position limits for non-FLEX index

options on the same index.42

Accordingly, FLEX market index

options currently approved for nonFLEX options trading will be subject to

a separate position limit of 200,000

contracts on the same side of the

market.43 FLEX industry index 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.44

The Exchange notes that FLEX market

index option limits are the same as the

provisions of other exchanges.45 The

Exchange also believes that four times

the non-FLEX limit is an appropriate

limit for FLEX industry index options.46

Respecting FLEX equity options, the

Exchange proposes to eliminate the

application of position and exercise

limits under a two-year pilot program.47

Rule 1079(d)(2) would continue to state

that position limits for non-FLEX equity

options shall not be taken into account

when calculating position limits for

non-FLEX equity options, or FLEX or

non-FLEX index options.

The Exchange is proposing to add that

each member or member organization

(other than a Specialist or Registered

Options Trader) that maintains a

position on the same side of the market

in excess of three times the level

established pursuant to Rule 1001 for

non-FLEX equity options of the same

class on behalf of its own account of a

customer shall report information on the

FLEX equity option position, positions

in any related instrument, the purpose

or strategy for the position and the

collateral used by the account. This

report shall be in the form and manner

prescribed by the Exchange. In addition,

whenever the Exchange determines that

a higher margin requirement is

necessary in light of the risks associated

with a FLEX equity option position in

excess of three times the level

established for non-FLEX equity options

of the same class, the Exchange may

impose such higher margin requirement

and/or may assess capital charges upon

the member organization carrying the

account to the extent of any margin

deficiency resulting from the higher

margin requirement.

The Exchange notes that the purpose

of the amendment is to compete with

the other option exchanges’ that have

been approved for identical position

limit treatment for FLEX equity

options,48 and to attract additional

investor interest, and to structure FLEX

equity options in a more flexible

fashion. There will still, however, be

position and exercise limits for FLEX

index options, as described above.

The Exchange believes that the

elimination of position/exercise limits

for FLEX equity options is appropriate

in light of the institutional nature of the

product. Phlx states that one particular

potential institutional use of FLEX

options is for stock repurchase

programs, which can be utilized by

stock issuers in the form of put sales.

The Exchange believes that eliminating

position limits may attract this business,

and thus, bring significant options

volume into the realm of exchange

trading.49

The Exchange believes that attracting

additional market participation to FLEX

equity options should improve liquidity

and the quality of FLEX markets for all

participants. The amendment would

require member organizations to report

positions exceeding three times the nonFLEX position limit in that option.

Whenever a member files such a report

with the Exchange, the Exchange may

request a higher margin requirement in

light of the risks associated with such a

FLEX equity options position. Thus, the

Exchange believes that the amendment

is reasonable and consistent with the

market protection and antimanipulation purposes of position/

exercise limits. Enhanced reporting is
3606 Federal Register / Vol. 63, No. 15 / Friday, January 23, 1998 / Notices

50See Phlx Rule 703.

51See Phlx Rule 703.

52Under this proposal, 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, in advance, prior to making any such

change. Any proposal to expand trading hours

outside of established regular trading hours would

have to be submitted as a proposed rule change to

the Commission pursuant to Section 19(b) of the

Act.

53See Floor Procedure Advices 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.

intended to facilitate the Exchange’s

surveillance function respecting larger

FLEX positions.

The exercise limit for FLEX index

options would apply, equivalent to the

applicable FLEX index option position

limit. The minimum exercise size,

however, would be the lesser of $1

million or the remaining size of the

position respecting index options, and

the lesser of 25 contracts or the

remaining size of the position respecting

equity options.

The proposal requires any ROT and

Specialist to submit a Letter of

Guarantee 50 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

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.51

The Exchange also proposes to adopt

Floor Procedure Advice F–28, Trading

FLEX Index and Equity 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.

There will be no trading rotations in

FLEX options, either at the opening or

at the close of trading. The Exchange

has determined that, initially, FLEX

options will begin trading at 10:00 a.m.,

one half hour after the normal opening

of trading non-FLEX options on the

Exchange, in order to limit the burden

on the trading crowd. FLEX industry

index and equity options will trade

until 4:02 p.m., to correspond to the

non-FLEX options similar to FLEX

market index options, which would

trade until 4:15 p.m. The Exchange may

establish other trading times for FLEX

options within the regular trading hours

for the non-FLEX options, including

coordination with FLEX trading hours

on other exchanges and reflecting new

trading hours for non-FLEX options.52

In addition, 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 Phlx believes, therefore, that the

response time and the BBO

Improvement Interval should thus

promote depth and liquidity.

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.53

In addition, the minimum size

requirements are intended to attract

depth and liquidity to FLEX options.

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 midmonth Friday expiration for options.

Because the expiration date of FLEX

options may not correspond to a nonFLEX expiration, FLEX options should

not affect the market for the underlying

securities 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 index options,

although separate from those applicable

to non-FLEX index options. The

Exchange believes that separate, higher

limits and non-aggregation are

appropriate for FLEX index 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 index options.

Although FLEX options are

characterized by variable terms, not all

FLEX option terms can be customized.

As stated above, the expiration date

cannot fall on certain days.

Customization of FLEX equity 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, Americanstyle FLEX index options exercised

prior to the expiration date can only

settle based on the closing value on the

exercise date. Despite these restrictions

on customization, the Phlx believes

FLEX options should nevertheless

address a market need for variation in

contract terms.

The Exchange believes that FLEX

options not only 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

FLEX index and equity 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 much 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
Federal Register / Vol. 63, No. 15 / Friday, January 23, 1998 / Notices 3607

54The 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.

55The Exchange notes that the Options

Committee may determine to established an

abbreviated response time for a new RFQ, because

the full ten minutes may not be required for pricing

determinations.

56See e.g., CBOE Rule 24A.6, which states that a

Floor Broker may be given discretion with respect

to the number of FLEX contracts to be purchased

or sold.

57 If the option is not listed on the Exchange,

specialist functions may be allocated by the

Exchange pursuant to Phlx Rules 500 et seq.

58See Floor Procedure Advice F–2, Time

Stamping, Matching and Access to Matched Trades.

59 15 U.S.C. 78f(b)(5).

60 15 U.S.C. 78k–1.

61 In approving this rule, the Commission notes

that it has considered the proposed rule’s impact on

efficiency, competition, and capital formation. 15

U.S.C. 78c(f).

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 nonFLEX 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.54 When trading with a

booked order, a member must re-quote

the market and announce the trade.

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 nonFLEX 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. The

market must be re-quoted before a

member attempts to trade on an existing

RFQ. 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.55

Certain aspects of proposed Rule 1079

differ from FLEX provisions of other

exchanges. For instance, discretionary

transactions would not be permitted in

FLEX index and equity options.56 Thus,

the existing provisions of Rule 1065 will

apply to prohibit such transactions.

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.57 but is not required to do so in

order to participate. Instead, the nonFLEX 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 procure.58

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.

IV. Discussion

The Commission finds that the

proposals are consistent with the

requirements of the Act and the rules

and regulations thereunder applicable to

a national securities exchange, and, in

particular, the requirements of Sections

6(b)(5) 59 and 11A 60 of the Act.

Specifically, the Commission finds that

the Exchange’s proposal is designed to

provide investors with a tailored or

customized product for eligible index

and equity options that may be more

suitable to their investment needs.

Moreover, consistent with Section 11A

of the Act, the proposal should

encourage fair competition among

brokers and dealers and exchange

markets, by allowing the Exchange to

compete with the growing OTC market

in customized index and equity options.

The Commission believes the

Exchange’s proposal reasonably

addresses its desire to meet the

demands of sophisticated portfolio

managers and other institutional

investors who are increasingly using the

OTC market in order to satisfy their

hedging needs. Additionally, the

Commission believes that the

Exchange’s proposal will help promote

the maintenance of a fair and orderly

market, consistent with Sections 6(b)(5)

and 11A of the Act, because the purpose

of the proposal is to extend the benefits

of a listed, exchange market to index

and equity options that are more flexible

than current listed options and that

currently trade OTC. The benefits of the

Exchange’s options market include, but

are not limited to, a centralized market

center, an auction market with posted

transparent market, quotations and

transaction reporting, parameters and

procedures for clearance and settlement,

and the guarantee of OCC for all

contracts traded on the Exchange.61

The Commission believes the

Exchange’s trading procedures for FLEX

index and equity options are reasonably

designed to provide some of the benefits

of an Exchange auction market along

with features of a negotiated transaction

between investors. In approving the

proposal, the Commission recognizes

that the Exchange’s proposed FLEX

option trading program will allow the

trading of option contracts of substantial

value, for which continuous quotations

may be difficult to sustain. The

Commission believes that the Exchange

has adequately addressed these

concerns by establishing procedures for

quotes upon request, which must be

firm for a designated period of time and

which will be disseminated through

OPRA.

The Commission also believes that it

is reasonable that an RFQ remain open

for that particular trading day once a

BBO is established. Specifically, the

Commission believes that if the

Requesting Member does not accept the

BBO, it is reasonable for the Exchange

to allow the RFQ to remain open so that

the trading crowd may re-quote the

market in response to the same contract

set forth in the existing RFQ without

submitting another RFQ.

The Commission notes that this

provision only allows a member to requote the market later in the day with

respect to the open RFQ from which a

trade has not been executed.

The Commission also believes that it

is reasonable for the Exchange to allow

for FLEX orders to be accepted onto a

FLEX limit order book. As noted above,

the Specialist in the listed non-FLEX

equity or index option, whether or not
3608 Federal Register / Vol. 63, No. 15 / Friday, January 23, 1998 / Notices

62 15 U.S.C. 78k.

63 17 CFR 240.11a1–1(T).

64 17 CFR 240.11b–1. 65See supra note 52.

66The Commission notes that the Exchange must

file a proposed rule change with the Commission,

pursuant to Section 19(b) of the Act, to withdraw

or modify this exercise price policy regarding FLEX

equity call options.

67Of course, investors will also be able to

designate exercise price for FLEX equity put

options and FLEX index call and put options.

68The Commission notes, that OCC, in the

approved FLEX equity option 9b–1 ODD

supplement, informs investors of the limitation of

exercise price intervals when writing FLEX equity

call options. See FLEX equity options 9b–1 order,

supra note 18.

assigned in FLEX options, will maintain

a FLEX limit order book. The

Commission believes that a FLEX limit

order book, maintained by a Specialist,

should help to accommodate FLEX

options trading.

The Commission notes that the Phlx

is the first exchange to create a limit

order book for FLEX options. The

Commission believes that by

establishing both a FLEX and non-FLEX

limit order book for the same option

classes, the Exchange should monitor

the use of the FLEX limit order book to

ensure that members are not using the

limit order book to trade ahead of nonFLEX limit orders for the same options

class. The Commission believes that this

concern is minimized because FLEX

options should generally have an

expiration date at least two days before

or after the expiration date for the

corresponding non-FLEX option, thus

FLEX and non-FLEX option contracts

are not fungible.

Additionally, the Commission

believes that the Exchange’s proposal to

provide a minimum right of

participation of at least 25% of the trade

to Exchange members who initiate

Requests for Quotes in respect of FLEX

options and indicate an intention to

cross or act as principal on the trade, is

consistent with the Act. In addition,

under Phlx rules, all FLEX options

transactions must be in compliance with

the priority, parity, and precedence

requirements of Section 11 of the Act,62

and Rules 11a1–1(T) 63 and 11b–1,64

promulgated thereunder. These

provisions set forth, among other things,

the conditions in which members must

yield priority to public customers’ bids

and offers at the same price.

The Commission also believes that the

Exchange’s proposal to require at least

two assigned ROTs, or an assigned

specialist and an assigned ROT for each

FLEX option class, is consistent with

the Act. The Commission notes that the

Exchange’s rules currently provide a

framework that encourages assigned

ROTs and specialists, to actively make

responsive quotes to provide liquidity

in FLEX options. In fact, assigned ROTs

and specialists, who respond to an RFQ,

must do so with a market of the

minimum size in response to the RFQ.

Further, assigned ROTs and specialists

must provide a market in any FLEX

option when requested by a Floor

Official. Accordingly, the Commission

believes that this requirement should be

sufficient to provide quotations in

response to an RFQ and generally

accommodate FLEX options trading.

The Commission also believes that the

Exchange’s proposal to permit FLEX

equity options trading on any optionseligible security regardless of whether

Non-FLEX equity options overlie that

security and trade on the Exchange is

reasonable, in that it promotes fair

competition among exchanges,

consistent with Section 11A of the Act,

and will perfect the mechanism of a free

and open market and serve to protect

investors and the public interest in

accordance with Section 6(b)(5) of the

Act. The Commission notes that Phlx

FLEX equity options must still meet the

eligibility requirements and criteria set

forth in Phlx Rule 1009.

In addition, the Commission believes

that the Exchange’s proposal to

designate all currently approved Phlx

index options as eligible for FLEX index

options trading is consistent with the

Act. The Commission notes, however,

that when submitting a Section 19(b)

proposal to list and trade a new nonFLEX index options product, the

Exchange must, in the same filing,

specifically propose to list and trade the

FLEX index options in the same

proposed rule change. If the Exchange is

not prepared at that time to seek

approval for the listing of FLEX options

overlying the proposed index, then the

Exchange should submit a rule filing

pursuant to Section 19(b) of the Act

proposing to list FLEX options on that

index at an appropriate time in the

future.

The Commission believes it is

consistent with Section 6(b)(5) of the

Act for the Phlx to establish trading

hours for FLEX options that begin thirty

minutes after the non-FLEX market

trading hours, and end at the same time

as normal non-FLEX market trading

hours. The Commission also believes

that because of the nature of the FLEX

market, in contrast to the Non-FLEX

market, it is reasonable to permit the

Exchange, in its discretion, to restrict or

expand trading hours for FLEX options,

so long as such trading hours occur

within the normal options trading hours

of the Exchange.65

The Commission believes that the

Exchange’s proposal to restrict exercise

prices for calls on FLEX equity options,

as described above, reasonably balances

the desire of sophisticated portfolio

managers and other institutional

investors to trade flexible equity options

products, with the need to eliminate the

potential that the trading of such

options could inadvertently impact a tax

benefit currently provided to writers of

standardized call options that qualify as

QCCs.66 In approving this provision, the

Commission recognizes that the

Exchange will restrict the flexibility of

investors in determining an essential

term of FLEX equity call options

contracts (i.e., the exercise price).

Nevertheless, investors will still be able

to designate contract terms for exercise

style (i.e., American or European) and

expiration date.67 Based on this and the

current tax framework for QCCs, the

Commission believes the limitations

imposed by the proposal is appropriate

and should still provide investors with

a more flexible product than one with

standardized option terms while

protecting investors in the standardized

equity call options market.68

The Commission also believes that it

is reasonable for the Exchange to

propose to eliminate position and

exercise limits for FLEX equity options

on a two-year pilot basis. While the

Commission has generally taken a

gradual, evolutionary approach toward

expansion of position and exercise

limits, the Commission is willing to

approve the two-year pilot program for

FLEX equity options for several reasons.

First, the FLEX equity options market is

characterized by large, sophisticated

institutional investors (or extremely

high net worth individuals), who have

both the experience and ability to

engage in negotiated, customized

transactions. For example, with a

required minimum size of 250 contracts

to open a transaction in a new series,

FLEX equity options are designed to

appeal to institutional investors, and it

is unlikely that many retail investors

would be able to engage in options

transactions at that size. Second, the

Exchange’s other rules and provisions

governing FLEX equity options will

remain applicable. Third, the OCC will

serve as the counter-party guarantor in

every exchange-traded transaction.

Fourth, the proposed elimination of

position and exercise limits for FLEX

equity options could potentially expand

the depth and liquidity of the FLEX

equity market without significantly

increasing concerns regarding

intermarket manipulations or
Federal Register / Vol. 63, No. 15 / Friday, January 23, 1998 / Notices 3609

69For a more complete discussion of the

Commission’s findings regarding the elimination of

FLEX equity options position limits, see FLEX

Equity Option Position Limit Approval Order,

supra note 50.

70See Securities Exchange Act Release No. 33582

(February, 1994).

71See, e.g., Securities Exchange Act Release No.

30944 (July 21, 1992), 57 FR 33376 (July 28, 1992).

72 Id.

disruptions of the options or the

underlying securities. Finally, the

Exchange’s surveillance programs will

be applicable to the trading of FLEX

equity options and should detect and

deter trading abuses arising from the

elimination of position and exercise

limits.

As described above, the Exchange

have adopted important safeguards that

will allow them to monitor large

positions in order to identify instances

of potential risk and to assess additional

margin and/or capital charges, if

necessary. By monitoring accounts in

excess of three times the Non-FLEX

equity option position limit in this

manner, the Exchange should be

provided with the information

necessary to determine whether to

impose additional margin and/or

whether to assess capital charges upon

a member organization carrying the

account. In addition, this information

should allow the Exchange to determine

whether a large position could have an

undue effect on the underlying market

and to take the appropriate action.

Given the size and sophisticated

nature of the FLEX equity options

market, along with the new reporting

and margin requirements, the

Commission believes that eliminating

position and exercise limits for FLEX

equity options for a two-year pilot

period should not substantially increase

manipulative concerns. Nevertheless,

the Commission will be able to assess

the effects on the markets of the

Exchange’s proposals during the twoyear pilot period. If problems were to

arise during such pilot period, the

Commission believes that the enhanced

market surveillance of large positions

should help the Exchange to take the

appropriate action in order to avoid any

manipulation or market risk concerns.

Nevertheless, because the

Commission has only recently agreed to

eliminate position and exercise limits

for a derivative product, the

Commission cannot rule out the

potential for adverse effects on the

securities markets for the component

securities underlying FLEX equity

options. To address this concern, the

Commission has approved the proposal

for a two-year pilot period. The

Exchange will undertake to monitor,

among other things, open interest and

potential adverse market effects and to

report to the Commission on the status

of the program no later than eighteen

months after the order’s date of

effectiveness. The reporting of the

Exchange’s experiences should include,

among other things, such information

as:

(i) The type of strategies used by FLEX

equity options market participants and

whither FLEX equity options are being used

in lieu of existing standardized equity

options;

(ii) the type of market participants using

FLEX equity options during the pilot

program;

(iii) the average size of the FLEX equity

option contract during the pilot program, the

size of the largest FLEX equity option

contract on any given day during the pilot

program, and the size of the largest FLEX

equity option held by a single customer/

member during the pilot program; and

(iv) any impact on the prices of underlying

stocks during the establishment or

unwinding of FLEX positions that are greater

than three times the standard non-FLEX

equity option position limits.69

The Commission also believes that it

is reasonable for the Exchange to

conform its rules to the rules of other

options exchanges to reduce from 100

contracts to 25 contracts the minimum

value size of closing transactions in and

exercises of FLEX equity options. The

Commission notes that market

participants wanting to execute an

opening transaction in a particular

series of FLEX equity options will

continue to be required to meet the 250

(if no open interest in a particular FLEX

series) or 100 (if open interest in a

particular FLEX series) minimum

contract requirement. The Commission

believes that this should help to ensure

that transactions in FLEX equity options

remain of substantial size and, therefore,

the product is geared to an institutional,

rather than a retail market.

The Commission also believes that the

Phlx’s proposal to include certain

designated foreign currencies in the list

of variable FLEX index option contract

terms is a reasonable response by the

Exchange to meet the demands of

sophisticated portfolio managers and

other institutional investors.

Additionally, the Commission believes

that the Phlx’s proposal will help to

promote the maintenance of a fair and

orderly market because it extends the

benefits of a listed exchange market to

FLEX index options that trade and settle

in certain designated foreign currencies.

The Commission believes that

investors should benefit from the

additional flexibility by permitting them

to designate quotation and settlement

terms in various foreign currencies

while continuing to ensure adequate

investor protection in the trading of

these products. The potential risk of

settling FLEX options in foreign

currencies rather than U.S. dollars is

also disclosed in the ODD pursuant to

Rule 9b–1 of the Act.70

The Commission also notes that FLEX

index options can be constructed with

expiration exercise settlement based on

the closing values of the component

securities, which could potentially

result in adverse effects for the markets

in these securities.71 Although the

Commission continues to believe that

basing the settlement of index products

on opening as opposed to closing prices

on Expiration Friday helps alleviate

stock market volatility,72 these market

impact concerns are reduced in the case

of FLEX options because expiration of

these options will not correspond to the

normal expiration of Non-FLEX options,

stock index futures, and options on

stock index futures. In particular, FLEX

options, will never expire on any

‘‘Expiration Friday.’’ More specifically,

the expiration date of a FLEX option

may not occur on a day that is on, or

within, two business days of the

expiration date of a Non-FLEX option.

The Commission believes that this

should reduce the possibility that the

exercise of FLEX options at expiration

will cause any additional pressure on

the market for underlying securities at

the same time that Non-FLEX options

expire.

In addition, the proposal would limit

the effect on securities markets by

addressing the relationship between

FLEX index options and QIXs. As

proposed, Phlx Rule 1079(d)(1) requires

P.M.-settled FLEX options to be

aggregated with QIXs that are based on

the same index and have the same

expiration date. In such a case, the

FLEX options would be aggregated two

days prior to expiration subject to the

position limits for the QIX options on

the applicable index. The Commission

believes that these rules should help

prevent an investor from using FLEX

options for the purpose of avoiding the

position limits applicable to QIXs.

Nevertheless, because the position

limits for both FLEX index options are

much higher than those currently

existing for outstanding exchangetraded index options (and FLEX equity

options have no position limit

requirements) and open interest in one

or more FLEX option series could grow

to significant levels, it is possible that

FLEX options might have an impact on

the securities markets for the securities

underlying FLEX options. The

Commission expects the Exchange to
3610 Federal Register / Vol. 63, No. 15 / Friday, January 23, 1998 / Notices

73The minimum size for an opening transaction

in FLEX equity options is 250 contracts for any

FLEX series in which there is no open interest, and

100 contracts in any currently opened FLEX series.

74See Letter from Joseph P. Corrigan, Executive

Director, OPRA, to Sharon Lawson, Senior Special

Counsel, OMS, Market Regulation, Commission,

dated October 20, 1997. (‘‘OPRA Capacity Letter’’).

75As noted supra in note 8, Amendment No. 4

supersedes Amendment No. 3, in its entirety.

monitor the actual effect of FLEX

options once trading commences and

take prompt action (including timely

communication with the self-regulatory

organizations responsible for oversight

of trading in the underlying securities)

should any unusual market effects

develop.

The Exchange represents that FLEX

options will allow them to compete

with OTC markets and help meet the

demand for customized options

products by institutional investors. The

minimum value sizes for opening

transactions in FLEX options are

designed to appeal to institutional

investors, and it is unlikely that most

retail investors would be able to engage

in options transactions at that size.

Nevertheless, the FLEX equity option

minimum size for opening

transactions 73 is much smaller than that

for FLEX index options. The

Commission also notes that, in

approving the proposal to establish 25

contracts as the minimum contract

requirement for closing transactions in,

and exercises of, FLEX equity options,

adequate surveillance guidelines should

be in place to ensure that only

sophisticated investors with the

necessary financial resources to sustain

the possible losses arising from

transactions in the requisite FLEX

options class size are utilizing this

product. The Commission’s staff has

reviewed Phlx’s surveillance program

and believes it provides a reasonable

framework in which to monitor such

investor open interest.

Because of these established

minimum contract requirements for

both opening and closing transactions in

FLEX equity options, the Commission

requests that the Exchange monitor its

respective comparative levels of

institutional and retail investor open

interest in FLEX equity options for one

year from the commencement of its

FLEX equity option trading program. In

particular, the Commission requests that

the Exchange provide a report to the

Commission’s Division of Market

Regulation describing the nature of

investor participation (i.e., retail vs.

institutional) in FLEX equity options no

later than two months following the

one-year anniversary of FLEX equity

options trading on the Exchange. If the

Exchange determines in the interim that

the proposed rule change has resulted in

a pattern of retail investor participation

in FLEX equity options, it should notify

the Commission’s Division of Market

Regulation to determine if (1) the

minimum contract requirements for

opening transactions should be

increased from 250 contracts, and/or (2)

the minimum contract requirements for

closing truncations should be restored

to the originally proposed level.

The Commission also notes that

effective surveillance guidelines are

essential to ensure that the Exchange

has the capacity to adequately monitor

trading in FLEX options for potential

trading abuses. The Commission’s staff

has reviewed Phlx’s surveillance

program and believes it provides a

reasonable framework in which to

monitor the trading of FLEX options on

its trading floor and detect as well as

deter manipulation activity and other

trading abuses.

In order to ensure adequate systems

processing capacity to accommodate the

additional options listed in accordance

with the FLEX options program, OPRA

has concluded that the additional traffic

generated by FLEX index and equity

options traded on the Phlx is within

OPRA’s capacity.74

The Commission finds good cause for

approving Amendment No. 2 prior to

the thirtieth day after the date of

publication of notice of filing thereof in

the Federal Register. Specifically, this

amendment proposes that (1) the RFQ

include the size and intention to cross,

consistent with the existing procedures

of other exchanges; and (2) a specific

position limit of 22,000 contracts for the

Super Cap Index option be adopted. The

Commission believes that the proposed

amendment further clarifies the

proposal and does not raise any new or

unique regulatory issues.

Accordingly, the Commission

believes, consistent with Section 6(b)(5)

of the Act, that good cause exists, to

approve Amendment No. 2 to the

proposal on an accelerated basis.

The Commission finds good cause for

approving Amendment No. 4 prior to

the thirtieth day after the date of

publication of notice of filing thereof in

the Federal Register 75 Specifically, as

noted above, the Exchange’s proposal to

(1) eliminate the application of position

and exercise limits to FLEX equity

options for a two-year pilot period; and

(2) reduce the minimum size applicable

to a Request-for-Quote for a closing

transaction in already-opened FLEX

equity options from 100 to 25 contracts,

are identical to proposals by other

options exchanges that were recently

approved by the Commission.

Therefore, the Commission believes that

the proposal raises no new regulatory

issues.

Further, the Commission believes that

other changes incorporated into

Amendment No. 4, including, proposals

to: (1) amend the proposal rule change

to refer consistently to ‘‘FLEX index and

equity options’’ (as opposed to index

FLEX options); (2) correct the text of

proposed Rule 1079(b)(6) regarding the

crossing procedure to reflect that the

crossing intention has already been

announced as part of the RFQ, as

amended by Amendment No. 2; and (3)

amend proposed Rule 1079(a)(1) to

clearly state that any options-eligible

security pursuant to Rule 1009 to

eligible to underlie FLEX equity options

trading. The Commission also believes

that these amendments do not raise any

new regulatory issues.

Accordingly, the Commission

believes, consistent with Section 6(b)(5)

of the Act, that good cause exists, to

approve Amendment No. 4 to the

proposal on an accelerated basis.

The Commission finds good cause for

approving Amendment No. 5 prior to

the thirtieth day after the date of

publication of notice of filing thereof in

the Federal Register. Specifically, as

noted above, the Exchange’s proposed

amendment clarifies: (1) the parity and

priority principles for FLEX options

transactions; and (2) that each assigned

ROT or assigned Specialist is not

required to respond with a quote in

every instance, unless requested by a

Floor Official. These provisions are

substantially similar to those of other

options exchanges that were recently

approved by the Commission.

Therefore, the Commission believes that

the proposal raises no new regulatory

issues.

Accordingly, the Commission

believes, consistent with Section 6(b)(5)

of the Act, that good cause exists, to

approve Amendment No. 5 to the

proposal on an accelerated basis.

Interested persons are invited to

submit written date, views and

arguments concerning Amendment Nos.

2, 4 and 5 to the proposed rule change.

Persons making written submissions

should file six copies thereof with the

Secretary, Securities and Exchange

Commission, 450 Fifth Street, N.W.,

Washington, D.C. 20549. Copies of this

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
Federal Register / Vol. 63, No. 15 / Friday, January 23, 1998 / Notices 3611

76 17 CFR 240.9b–1 See supra note 9.

77 15 U.S.C. 78s(b)(2).

78 17 CFR 200.30–3(a)(12). 1 15 U.S.C. 78s(b)(1).

2The enhanced parity split for the specialist in

3D German Mark options was first approved on

December 29, 1994. See Securities Exchange Act

Release No. 35177 (Dec. 29, 1994), 60 FR 2419 (Jan.

9, 1995). 3D German Mark options are cash-settled,

European-style, cash/spot foreign currency option

contracts on the German Mark that trade in oneweek and two-week expirations.

3The enhanced parity split was eliminated as of

September 8, 1997. See Securities Exchange Act

Release No. 39030 (Sept. 8, 1997), 62 FR 48332

(Sept. 15, 1997). The sole specialist firm trading 3D

German Mark options indicated that the enhanced

parity split was not particularly useful and that it

did not generally take advantage of it. Furthermore,

the Exchange represented that the order size in 3D

German Mark options generally was not large

enough to trigger the application of the enhanced

parity split (i.e., such orders represented less than

100 contracts).

4The Exchange recently amended its enhanced

parity split pilot program for equity and index

option specialists to expand its application. As a

result of the amendment, all index options and all

newly listed equity options receive the enhanced

parity split. However, only 50% of those equity

options not considered ‘‘newly listed’’ are eligible

to receive the enhanced parity split. In addition,

specialists are now permitted to revise the list of

eligible equity options on a quarterly basis, rather

than an annual basis. See Securities Exchange Act

Release No. 39401 (Dec. 4, 1997), 62 FR 65300 (Dec.

11, 1997).

5 It should be noted that because FCOs on the

Italian Lira and the Spanish Peseta are traded as

customized options, there are no specialists

assigned to those products. For simplicity and

clarity, all further references to FCOs shall not

include these two products.

those that may be withheld from the

public in accordance with the

provisions of 5 U.S.C. 552, will be

available for inspection and copying at

the Commission’s Public Reference

Section, 450 Fifth Street, N.W.,

Washington, D.C. 20549. Copies of such

filing will also be available for

inspection and copying at the principal

office of the Exchange. All submissions

should refer to SR–Phlx–96–38 and

should be submitted by February 13,

1998.

V. Conclusion

For the reasons discussed above; the

Commission finds that the proposal is

consistent with the Act and Sections 6

and 11A of the Act, in particular. In

addition, the Commission has

previously concluded pursuant to Rule

9b–1 under the Act, that FLEX options,

including FLEX equity options and

FLEX index options, and FLEX index

options traded and settled in certain

designated foreign currencies, are

standardized options for purposes of the

options disclosure framework

established under Rule 9b–1 of the

Act.76 Apart from the flexibility with

respect to strike prices, expiration dates,

exercise styles, and settlement (for FLEX

index options), all of the other terms of

FLEX options are standardized pursuant

to OCC and Phlx rules.

Standardized terms include matters

such as exercise procedures, contract

adjustments, time of issuance, effect of

closing transactions, restrictions on

exercise under OCC rules, margin

requirements, and other matters

pertaining to the rights and obligations

of holders and writers.

It is therefore ordered, pursuant to

Section 19(b)(2) of the Act,77 that the

proposal (File No. SR–Phlx–96–38), as

amended, including Amendment Nos. 2,

4 and 5 on an accelerated basis, is

approved. In addition, the portion of the

proposal eliminating FLEX equity

options position and exercise limits is

approved on a pilot basis until January

14, 2000.

For the Commission, by the Division of

Market Regulation, pursuant to delegated

authority.78

Jonathan G. Katz,

Secretary.

[FR Doc. 98–1552 Filed 1–22–98; 8:45 am]

BILLING CODE 8010–01–M

SECURITIES AND EXCHANGE

COMMISSION

[Release No. 34–39552; File No. SR–Phlx–

97–55]

Self-Regulatory Organizations; Notice

of Filing of Proposed Rule Change by

the Philadelphia Stock Exchange, Inc.

Establishing an Enhanced Parity Split

Pilot Program for Specialists in

Foreign Currency Options Effective

Until December 31, 1998

January 14, 1998.

Purusant to Section 19(b)(1) of the

Securities Exchange Act of 1934

(‘‘Act’’),1 notice is hereby given that on

December 1, 1997, the Philadelphia

Stock Exchange, Inc. (‘‘Phlx’’ or

‘‘Exchange’’) filed with the Securities

and Exchange Commission

(‘‘Commission’’) the proposed rule

change as described in Items I, II, and

III below, which Items have been

prepared by the Exchange. 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 Exchange seeks to revise

Exchange Rule 1014(h) to establish an

enhanced parity split pilot program

(‘‘Pilot Program’’) for its foreign

currency option (‘‘FCO’’) specialists

effective until December 31, 1998.

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

Exchange 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

Exchange 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

1. Purpose

The Exchange previously provided

and enhanced parity split to the

specialist dealing in dollar denominated

delivery German Mark (‘‘3D German

Mark’’) options.2 The enhanced parity

split gave the specialist 50% of the first

500 contracts of any trade in 3D German

Mark options. The Exchange eliminated

the enhanced parity split earlier this

year because the specialist in 3D

German Mark options and other traders

of the product found it to be of little

benefit.3 At the time the enhanced

parity split was eliminated, the

Exchange informed the Commission that

it would continue to study the potential

use of an enhanced parity split for all

FCO specialists on a broader basis. This

proposed rule change sets forth the

Exchange’s plan for the expanded use of

the enhanced parity split in FCOs.

The Exchange seeks to implement an

enhanced parity split procedure similar

to the one currently applied to

transactions in equity and index options

at the Exchange.4 Under the Pilot

Program, however, the application of

the proposed FCO enhanced parity split

would be more widespread, and the

enhanced parity split would be

available to all FCO specialists assigned

to FCO products.5 The Pilot Program

would be in effect until December 31,

1998.

The enhanced parity split would

apply to the first 500 contracts in a FCO

transaction in a FCO transaction. When

the enhanced parity split is applied, the