[Federal Register Volume 73, Number 194 (Monday, October 6, 2008)]
[Notices]
[Pages 58279-58281]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E8-23490]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-58691; File No. SR-Phlx-2008-69]


Self-Regulatory Organizations; Notice of Filing and Immediate 
Effectiveness of Proposed Rule Change by the NASDAQ OMX PHLX, Inc. 
Relating to the Phlx XL Risk Monitor Mechanism

September 30, 2008.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on September 18, 2008, the NASDAQ OMX PHLX, Inc. (``Phlx'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``Commission'') the proposed rule change as described in Items I and 
II below, which Items have been prepared by Phlx. The Commission is 
publishing this notice to solicit comments on the proposed rule change 
from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Exchange, pursuant to Section 19(b)(1) of the Act \3\ and Rule 
19b-4 thereunder,\4\ proposes to amend Exchange Rule 1093, Phlx XL Risk 
Monitor Mechanism, to reflect a system change to its fully electronic 
trading platform for options, Phlx XL.\5\ The system change would 
eliminate the current size offset of long calls vs. long puts and short 
calls vs. short puts in the accounts of Exchange Streaming Quote 
Traders (``SQTs''),\6\ Remote Streaming Quote Traders (``RSQTs''),\7\ 
non-SQT ROTs,\8\ and specialists (collectively, ``Phlx XL 
participants'') when the Phlx XL system determines whether to engage 
the Risk Monitor Mechanism (as defined more fully below) by calculating 
the Net Offset Specified Engagement Size (as defined below).
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    \3\ 15 U.S.C. 78s(b)(1).
    \4\ 17 CFR 240.19b-4.
    \5\ See Securities Exchange Act Release No. 50100 (July 27, 
2004), 69 FR 44612 (August 3, 2004) (SR-Phlx-2003-59) [sic].
    \6\ An SQT is a Registered Options Trader (``ROT'') who has 
received permission from the Exchange to generate and submit option 
quotations electronically through an electronic interface with AUTOM 
via an Exchange approved proprietary electronic quoting device in 
eligible options to which such SQT is assigned. See Exchange Rule 
1014(b)(ii)(A).
    \7\ An RSQT is an ROT that is a member or member organization 
with no physical trading floor presence who has received permission 
from the Exchange to generate and submit option quotations 
electronically through AUTOM in eligible options to which such RSQT 
has been assigned. An RSQT may only submit such quotations 
electronically from off the floor of the Exchange. See Exchange Rule 
1014(b)(ii)(B).
    \8\ A non-SQT ROT is an ROT who is neither an SQT nor an RSQT. 
See Exchange Rule 1014(b)(ii)(C).
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    The text of the proposed rule change is available on the Exchange's 
Web site at http://www.phlx.com/regulatory/reg_rulefilings.aspx.

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 purpose of the proposed rule change is to provide Phlx XL 
participants with additional protection from the unreasonable risk 
associated with the execution of an excessive number of contracts 
resulting from near simultaneous executions in a single option issue.
Risk Monitor Mechanism
    In January, 2006, the Exchange adopted Rule 1093 and deployed the 
Phlx XL Risk Monitor Mechanism.\9\ The Phlx XL Risk Monitor Mechanism 
is a component of Phlx XL that counts the number of contracts traded in 
a particular option by each Phlx XL participant within a specified time 
period established by each Phlx XL participant (the ``specified time 
period''). The specified time period commences for an option when a 
transaction occurs in any series in such option. The specified time 
period may not exceed 15 seconds; Phlx XL participants may, however, 
set the specified time period for less than 15 seconds.
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    \9\ See Securities Exchange Act Release No. 53166 (January 23, 
2006), 71 FR 4625 (January 27, 2006) (SR-Phlx-2006-05).
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    The system engages the Risk Monitor Mechanism in a particular 
option when the counting program has determined that a Phlx XL 
participant has traded a Specified Engagement Size (as defined below), 
as established by such Phlx XL participant, during the specified time 
period. When such Phlx XL participant has traded the Specified 
Engagement Size during the specified time period, the Risk Monitor 
Mechanism automatically removes such Phlx XL participant's quotations 
from the Exchange's disseminated quotation in all series of the 
particular option until such Phlx XL participant submits a new, revised 
quotation.
Specified Engagement Size
    Each Phlx XL participant establishes a Specified Engagement Size 
for a particular option.\10\ When such Phlx XL participant has traded 
the Specified Engagement Size during the specified time period, the 
Risk Monitor Mechanism automatically removes such Phlx XL participant's 
quotations from the Exchange's disseminated quotation in all series of 
the particular option.
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    \10\ A Phlx XL participant could establish the Specified 
Engagement Size as 100% or greater of the number of contracts 
executed in each series during the specified time period relative to 
the disseminated size. For example, a Phlx XL participant could 
establish the Specified Engagement Size as 200%, in which case the 
Risk Monitor Mechanism would not be engaged until 200% of the number 
of contracts in each series have been executed during the specified 
time period relative to the disseminated size. A Phlx XL participant 
could also establish the Specified Engagement Size as, for example, 
120%, in which case the Risk Monitor Mechanism would not be engaged 
until 120% of the number of contracts in each series have been 
executed during the specified time period relative to the 
disseminated size. In any event, however, a Phlx XL participant may 
not establish a Specified Engagement Size that is less than 100%.
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    The Specified Engagement Size is determined as follows: For each 
series in an option, the counting program would determine the 
percentage that the number of contracts executed in that series 
represents relative to the disseminated size in that series (the 
``series percentage''). The counting program would then determine the 
sum of the series percentages in the

[[Page 58280]]

underlying option issue (the ``issue percentage''). Once the counting 
program determines that the issue percentage equals or exceeds a 
percentage established by the Phlx XL participant which may not be less 
than 100% (the ``Specified Percentage''), the number of executed 
contracts in the option issue equals the Specified Engagement Size.
Offset on the Opposite Side of the Market
    Currently, the Risk Monitor Mechanism calculates the number of 
contracts executed on one side of the market during the specified time 
period, and offsets that number of contracts by the number of contracts 
executed on the opposite side of the market during the specified time 
period. The purpose of this provision is to account for the offset in 
risk of one option position created by a position in the same option 
issue on the opposite side of the market. Because the risk in such a 
situation is generally neutral, the Exchange believes that Phlx XL 
participants should continue executing contracts until the actual risk 
that is created by the Specified Engagement Size is realized. The 
Specified Engagement Size is thus automatically offset by a number of 
contracts that are executed on the opposite side of the market in the 
same option issue during the specified time period (the ``Net Offset 
Specified Engagement Size'').
    Currently, the Risk Monitor Mechanism is engaged when the Net 
Offset Specified Engagement Size is for a number of contracts executed 
among all series during the specified time period that represents an 
issue percentage that is equal to or greater than the specified 
percentage. For example, currently a Phlx XL participant that buys 
calls and also sells calls or buys puts in the same option during the 
specified time period would have a Net Offset Specified Engagement Size 
as follows:

----------------------------------------------------------------------------------------------------------------
                                                                            Sell call/   Net offset
                     Series                          Size       Buy call     buy put        size      Percentage
----------------------------------------------------------------------------------------------------------------
Series 1.......................................          100           60           20           40           40
Series 2.......................................           50          100           80           20           40
Series 3.......................................          200          150          130           20           10
Series 4.......................................          150           75           60           15           10
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    Total......................................          500          385          290           95          100
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    In this example, 675 contracts have been executed during the 
specified time period (buy calls 385 + sell calls/buy puts 290). The 
Net Offset Specified Engagement Size for each series is determined by 
offsetting the number of contracts executed on the opposite side of the 
market for each series during the specified time period. The Risk 
Monitor Mechanism is engaged once the Net Offset Specified Engagement 
Size is executed for a net number of contracts among all series during 
the specified time period that represents an issue percentage that is 
equal to or greater than the specified percentage.
Proposed Amendment to Net Offset Specified Engagement Size
    As stated above, the Specified Engagement Size is automatically 
offset by the Net Offset Specified Engagement Size. Currently, for 
example, a Phlx XL participant that buys calls and also sells calls or 
buys puts in the same option during the specified time period has a net 
Offset Specified Engagement Size that takes into account all opposite 
sides of the Phlx XL participants, including offset sizes respecting 
long call vs. long put positions, and short call vs. short put 
positions.
    Long call and long put (and short call and short put) offsets 
ignore volatility risk associated with options. Since the inception and 
deployment on the Exchange of the Risk Monitor Mechanism, Phlx XL 
participants have experienced situations where the long call/long put 
offset and the short call/short put offset have unintentionally placed 
them at undue risk respecting market volatility.\11\
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    \11\ While the sensitivity of an options price relative to 
change in the price of the underlying security is measured in 
``delta'', the sensitivity of an options price relative to change in 
the volatility of the underlying security is measured in ``vega''. A 
relatively high vega in an options series means that the option has 
a relatively large extrinsic value (i.e., time premium of the 
option), thus affording more likelihood for the option premium price 
to deviate significantly, and a relatively low volatility means that 
the option has a relatively small extrinsic value, thus affording a 
smaller likelihood that the option price can change.
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    Specifically, any long option position, whether a put or call, 
involves a positive volatility. Conversely, any short option position, 
whether a put or call, involves a negative volatility. Therefore, a 
Phlx XL participant's account that includes a long call position and a 
long put position in the same option will have a total positive 
volatility among the two positions. The two positions, when combined, 
do not offset one another respecting volatility. Instead, the two 
positions, when combined, result in the aggregate positive volatility 
of the two positions.
    Similarly, any short option position, whether a put or call, 
involves a negative volatility.
    Therefore, a Phlx XL participant's account that includes a short 
call position and a short put position in the same option will have a 
total negative volatility among the two positions. The two positions, 
when combined, do not offset one another respecting volatility. 
Instead, the two positions, when combined, result in the aggregate 
negative volatility of the two positions.
    Initially, the Exchange intended to offset opposite side positions 
when determining the Net Offset Specified Engagement Size because the 
delta (i.e., price change of the overlying option as a percentage of 
the price change in the underlying security) risk of each respective 
position was offset by the other. The Exchange did not, however, 
consider the aggregate volatility created by a long call/long put or 
short call/short put position. This combination results in a total 
aggregate volatility, and such volatility is not offset by the 
respective positions in the aggregate.
    Accordingly, the Exchange proposes to eliminate the call/put offset 
provision from the Risk Monitor Mechanism and from the text of Rule 
1093 in order to eliminate the undue volatility risk currently imposed 
on Phlx XL participants in this circumstance. The proposed rule change 
provides that long call positions will only be offset by short call 
positions (and vice versa), and long put positions will only be offset 
by short put positions. Eliminating the call/put offset provides 
greater protection for Phlx XL participants who seek to minimize their 
risk exposure when utilizing the Risk Monitor Mechanism. The Exchange 
believes that this protection should result in larger sized bids and 
offers made by Phlx XL participants, thus adding liquidity to the 
Exchange's markets while protecting

[[Page 58281]]

Phlx XL participants from exposure to undue volatility risk respecting 
options positions.
2. Statutory Basis
    The Exchange believes that its proposal is consistent with Section 
6(b) of the Act \12\ in general, and furthers the objectives of Section 
6(b)(5) of the Act \13\ in particular, in that it is designed 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, by providing Phlx XL participants with additional protection 
from exposure to undue market risk through the Risk Monitor Mechanism.
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    \12\ 15 U.S.C. 78f(b).
    \13\ 15 U.S.C. 78f(b)(5).
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    The Exchange further believes that the proposed rule change is 
consistent with the Act because the risk protection afforded Phlx XL 
participants by way of elimination of the long put/call and short put/
call offsets should encourage them to quote options series with greater 
size, adding liquidity to the Exchange's markets against which 
customers can trade.

B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange does not believe that the proposed rule change will 
impose any burden on competition not necessary or appropriate in 
furtherance of the purposes of the Act.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants or Others

    No written comments were either solicited or received.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Because the proposed rule change effects a change in an existing 
order-entry or trading system that: (i) Does not significantly affect 
the protection of investors or the public interest; (ii) does not 
impose any significant burden on competition; and (iii) does not have 
the effect of limiting the access to or availability of the system, the 
proposed rule change has become effective pursuant to Section 
19(b)(3)(A) of the Act \14\ and subparagraph (f)(5) of Rule 19b-4 
thereunder.\15\
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    \14\ 15 U.S.C. 78s(b)(3)(A).
    \15\ 17 CFR 240.19b-4(f)(5).
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    At any time within 60 days of the filing of the proposed rule 
change, the Commission may summarily abrogate such rule change if it 
appears to the Commission that such action is necessary or appropriate 
in the public interest, for the protection of investors, or otherwise 
in the furtherance of the purposes of the Act.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. Comments may be submitted by any of 
the following methods:

Electronic Comments

    <bullet> Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
    <bullet> Send an e-mail to <a href="/cdn-cgi/l/email-protection#5321263f367e303c3e3e363d2720132036307d343c25"><span class="__cf_email__" data-cfemail="94e6e1f8f1b9f7fbf9f9f1fae0e7d4e7f1f7baf3fbe2">[email protected]</span></a>. Please include 
File Number SR-Phlx-2008-69 on the subject line.

Paper Comments

    <bullet> Send paper comments in triplicate to Secretary, Securities 
and Exchange Commission, 100 F Street, NE., Washington, DC 20549-1090.

All submissions should refer to File Number SR-Phlx-2008-69. This file 
number should be included on the subject line if e-mail is used. To 
help the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). Copies of the submission, all subsequent amendments, all 
written statements with respect to the proposed rule change that are 
filed with the Commission, and all written communications relating to 
the proposed rule change between the Commission and any person, other 
than those that may be withheld from the public in accordance with the 
provisions of 5 U.S.C. 552, will be available for inspection and 
copying in the Commission's Public Reference Room, 100 F Street, NE., 
Washington, DC 20549, on official business days between the hours of 10 
a.m. and 3 p.m. Copies of such filing also will be available for 
inspection and copying at the principal office of Phlx. All comments 
received will be posted without change; the Commission does not edit 
personal identifying information from submissions. You should submit 
only information that you wish to make available publicly. All 
submissions should refer to File Number SR-Phlx-2008-69 and should be 
submitted on or before October 27, 2008.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\16\
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    \16\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Acting Secretary.
[FR Doc. E8-23490 Filed 10-3-08; 8:45 am]
BILLING CODE 8011-01-P


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