Document ID: SEC-2010-1920-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: NASDAQ OMX PHLX LLC
Posted Date: 2010-12-15T05:00Z

[Federal Register Volume 75, Number 240 (Wednesday, December 15, 2010)]
[Notices]
[Pages 78320-78327]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2010-31487]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-63509; File No. SR-Phlx-2010-157]

Self-Regulatory Organizations; NASDAQ OMX PHLX LLC; Notice of 
Filing of Proposed Rule Change, as Modified by Amendment No. 1, 
Relating to Complex Orders

December 9, 2010.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4\2\ thereunder, notice is hereby given that 
on November 29, 2010, NASDAQ OMX PHLX LLC (``Phlx'' or ``Exchange'') 
filed with the Securities and Exchange Commission (``SEC'' or 
``Commission'') the proposed rule change as described in Items I, II, 
and III, below, which Items have been prepared by the Exchange. On 
December 6, 2010, the Exchange filed Amendment No. 1 to the proposed 
rule change. The Commission is publishing this notice to solicit 
comments on the proposed rule change, as modified by Amendment No. 1, 
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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[[Page 78321]]

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 Rule 1080.08 to change the 
following aspects of its Complex Orders System: (i) Permit Complex 
Orders where one of the components of the Complex Order is the 
underlying security (stock or Exchange Traded Fund Share (``ETF'')); 
(ii) permit Complex Orders with more than two components; (iii) add a 
``Do Not Auction'' condition for Complex Orders that prevents orders so 
marked from triggering (or joining) a Complex Order Live Auction; \5\ 
(iv) permit day orders to be sent by certain participants; (v) add an 
execution priority provision that clarifies execution priority 
respecting current Complex Orders and establishes the execution 
priority of the proposed new Complex Orders; and (vi) revise the 
definition section.
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    \3\ 15 U.S.C. 78s(b)(1).
    \4\ 17 CFR 240.19b-4.
    \5\ See Rule 1080.08(e).
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    The text of the proposed rule change is available on the Exchange's 
Website at http://www.nasdaqtrader.com/micro.aspx?id=PHLXRulefilings, 
at the principal office of the Exchange, and at the Commission's Public 
Reference Room.

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
    In 2008, the Exchange automated the handling of Complex Orders on 
its electronic trading platform for options, Phlx XL.\6\ Currently, the 
Exchange's Complex Orders functionality is limited to Complex Orders 
consisting solely of two option components. The Exchange proposes to 
add Complex Orders where one component is the underlying stock or ETF. 
The Exchange also proposes to permit Complex Orders consisting of up to 
six components. The purpose of the proposed rule change is to more 
efficiently handle these new Complex Orders on the Exchange by 
establishing rules and systems that would enable the Exchange to handle 
such orders electronically.\7\
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    \6\ Securities Exchange Act Release No. 58361 (August 14, 2008), 
73 FR 49529 (August 21, 2008) (SR-Phlx-2008-50). Since that time, 
the Exchange has enhanced its options trading platform, now known as 
Phlx XL II. See Securities Exchange Act Release No. 59995 (May 28, 
2009), 74 FR 26750 (June 3, 2009) (SR-Phlx-2009-32).
    \7\ Currently, complex orders also trade on the floor of the 
Exchange pursuant to various rules, including Rule 1033; this 
proposal does not impact such manual trading.
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Definitions
    The Exchange is proposing to revise the definition of Complex Order 
in Rule 1080.08(a)(i) to provide that a Complex Order is any order 
involving the simultaneous purchase and/or sale of two or more 
different options series in the same underlying security, priced at a 
net debit or credit based on the relative prices of the individual 
components, for the same account, for the purpose of executing a 
particular investment strategy.\8\ Furthermore, a Complex Order can 
also be a stock-option order, which is an order to buy or sell a stated 
number of units of an underlying stock or ETF coupled with the purchase 
or sale of options contract(s).\9\ Accordingly, the Exchange is now 
permitting one component of a Complex Order to consist of the 
underlying stock or ETF.\10\ A Complex Order with one component that is 
the underlying stock or ETF is also referred to as a stock-option 
order. The underlying stock or ETF must be the deliverable for the 
options component of that Complex Order and represent exactly 100 
shares per option for regular way delivery.\11\ In the case of Complex 
Orders with a stock or ETF component, these cannot be executed against 
orders for the individual legs; stock-option orders in the System can 
only be executed against other stock-option orders. The Exchange is 
proposing to state that the maximum number of components will be six, 
including both options and stock components. For example, under the 
proposal, a Complex Order could consist of up to five options series 
plus the underlying security. Or, a Complex Order could consist of up 
to six options series.
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    \8\ This includes additional language that provides that a 
Complex Order is priced at a net debit or credit based on the 
relative prices of the individual components, which is currently in 
the definition of Complex Order Strategy in Rule 1080.08(a)(ii), but 
fits better in the definition of Complex Order.
    \9\ This definition is similar to ISE Rule 722(a).
    \10\ The term ``stock'' is used interchangeably with 
``underlying security'' herein. In addition, in the case of foreign 
currency options and index options, the underlying cannot be a 
component of a Complex Order, because such underlying instrument is 
not a security and instead consists of actual foreign currency and 
an index, respectively, which are not currently included in the 
program the Exchange has developed.
    \11\ Because it must represent exactly 100 shares, there can be 
no cash component. For example, XRX bought ACS, resulting in an 
adjusted option trading under the symbol AGY; AGY options settle 
into 4.935 XRX shares plus $18.60 cash. See e.g., http://www.theocc.com/components/docs/market-data/infomemos/2010/feb/26947.pdf. Accordingly, because AGY options settle through delivery 
of XRX shares and cash rather than AGY shares, it would not possible 
to enter a AGY stock-option order. Instead, AGY Complex Orders can 
only consist of options components to be traded on the Exchange.
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    This revision of the definition of a Complex Order is intended to 
simplify the rule and recognizes that there are many types and 
permutations possible, as strategies develop and become more 
sophisticated.\12\ As a result of this revision of the definition of a 
Complex Order, several subparagraphs are being deleted because they are 
too specific and no longer needed, as they are covered under the new, 
broader definition; these include the definition of a spread order, a 
straddle order, a combination order, a ratio order, a collar order, and 
a tied hedge order.\13\
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    \12\ The ISE has adopted a similar generic provision. See 
Securities Exchange Act Release No. 59021 (November 26, 2008), 73 FR 
74545 (December 8, 2008) (SR-ISE-2008-91).
    \13\ See current Phlx Rule 1080.08(a)(i)(A)-(F).
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    In Rule 1080.08(a)(ii), the Exchange is also revising the 
definition of Complex Order Strategy, in addition to moving the pricing 
language, as explained above, to expressly state in the rule that each 
such strategy is assigned a strategy identifier by the System.\14\ This 
is intended to make the program clearer in the rules. The Exchange is 
also proposing to better state that a Complex Order Strategy means a 
particular combination of components and their ratios to one another.
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    \14\ For example, a Complex Order Strategy might be ``buy one 
XYZ January 20 call, sell one XYZ January 20 put.'' The System would 
assign this Complex Order Strategy a specific identification number 
or code that would be used in the System to identify this Complex 
Order Strategy. Hypothetically, the identification number for this 
particular Complex Order Strategy could be ``Complex Order Strategy 
12345.'' Complex Order Strategy 12345 would have a 
bid price and an offer price. If an investor wishes to purchase or 
sell, for example, 10 Complex Order Strategy 12345, such an investor 
would be bidding for or offering to buy 10 XYZ January 20 calls and 
sell 10 XYZ January 20 puts. This is not a new feature and was 
included in the original proposal. See Securities Exchange Act 
Release No. 58361 (August 14, 2008), 73 FR 49529 (August 21, 2008) 
(SR-Phlx-2008-50).
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    In conjunction with permitting one of the components of a Complex 
Order to be the underlying security, the

[[Page 78322]]

Exchange proposes to amend subparagraphs (a)(iv) and (vi) to update the 
definitions of cPBBO and cNBBO, respectively, to include the underlying 
security. Specifically, both would be amended to state that the best 
net debit or credit price for a Complex Order Strategy that includes a 
stock/ETF component includes the national best bid or offer for the 
underlying security.
    The Exchange also proposes to adopt, in new subparagraph (a)(viii), 
a new order condition called ``Do Not Auction,'' or DNA, which causes 
an order to not be eligible to begin a Complex Order Live Auction 
(``COLA'').\15\ DNA Orders cannot join a COLA in progress. These orders 
can avoid an auction and, instead, be either executed immediately or 
cancelled.\16\ DNA Orders received prior to the opening or when the 
Complex Order Strategy is not available for trading will be cancelled. 
DNA Orders will initially only be available for Complex Orders 
consisting of more than two option components or where the underlying 
security is a component; once the Exchange has fully rolled out its 
enhanced Complex Order System, which will be announced in an Options 
Trader Alert, DNA Orders will also become available for Complex Orders 
consisting of two option components.
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    \15\ See Rule 1080.08(e).
    \16\ DNA orders can be marked IOC, which means that the order 
cannot start an auction (whereas an IOC order can), and get rejected 
if there is an auction in progress.
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Priority
    The Exchange proposes to clarify and expand upon the trade-through 
and execution priority provisions applicable to Complex Orders, 
including the expanded definition of Complex Orders. Accordingly, the 
Exchange, first, proposes to add to the definitions section of the 
rule, Rule 1080.08(a), the definition of a conforming ratio. A 
conforming ratio, in proposed Rule 1080.08(a)(ix), is essentially a 
permissible ratio, renamed. Specifically, it is where the ratio between 
the sizes of the options components of a Complex Order is equal to or 
greater than one-to-three (.333) and less than or equal to three-to-one 
(3.00). For example, a one-to-two (.5) ratio, a two-to-three (.667) 
ratio, or a two-to-one (2.00) ratio is a conforming ratio,\17\ whereas 
a one-to-four (.25) ratio or a four-to-one (4.0) ratio is not.\18\
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    \17\ One example of a conforming five-legged ratio is: B 100 GE 
Dec 12.50 calls for 4.00, S 200 GE Dec 15.00 calls for 2.00, B 100 
GE Dec 17.50 calls for .60 and also S 100 Dec 17.50/Dec 16.50 put 
spreads at .60; because the highest volume to the lowest volume is 
in a ratio of 2:1 (200 versus 100 options), this order is 
conforming.
    \18\ One example of a non-conforming five-legged ratio is: B 100 
GE Dec 12.50 calls for 4.00, S 200 GE Dec 15.00 calls for 2.00, B 
100 GE Dec 17.50 calls for .60 and also S 400 Dec 17.50/Dec 16.50 
put spreads at .60; because the highest volume to the lowest volume 
is in a ratio of 4:1 (400 versus 100 options), this order is not 
conforming.
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    Where one component of the Complex Order is the underlying 
security, the ratio between any options component and the underlying 
security component must be eight contracts to 100 shares of the 
underlying security or less.\19\ One example of a two-legged ratio 
order with a stock component that is conforming is: B 400 GE Dec 16.50 
calls, S 400 Dec 17.50 calls and S 12,000 shares of GE at 16.50; after 
comparing the largest option leg (400) to each 100 lot of shares (100 x 
120 = 12,000 shares, or 120 lots of 100), the ratio is 3.33 (400 
divided by 120) options per 100 shares, which is less than the maximum 
allowable 8 options per 100 shares, which is a conforming ratio. In 
contrast, B 200 GE Dec 16.50 calls, S 400 GE Dec 17.50 calls and S 
3,000 shares of GE at 16.50 is a nonconforming ratio, because comparing 
the largest leg of the options trade (400) to 30 lots of 100 (3,000 
shares) equals 13.33 (400 divided by 30) options per 100 shares, which 
is greater than the maximum allowable 8 options per 100 shares and thus 
nonconforming. Currently, the same ratio appears in Rule 
1080.08(a)(i)(D), within the definition of a Ratio Order; that 
provision is proposed to be deleted and replaced by the new definition 
of conforming ratio to make the rule clearer.\20\
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    \19\ These are the same ratios found in ISE Rule 722(a)(4). If 
the largest option leg versus stock meets the conforming ratio, 
then, necessarily, all smaller legs would also meet the definition 
of conforming ratio.
    \20\ Complex orders consisting of a nonconforming ratio will not 
be accepted.
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    Today, Complex Orders consisting of permissible (now called 
conforming) ratios are excepted from the trade-through prohibitions of 
the Options Order Protection and Locked/Crossed Market Plan (``Options 
Linkage Plan''), because the Plan contains an exception for Complex 
Orders with a certain ratio. Accordingly, these orders can be executed 
without regard to prices for the individual legs on other exchanges, 
meaning trading through possibly better prices.\21\ The Exchange now 
proposes to codify this in new subparagraph (c)(iii)(C).
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    \21\ See Securities Exchange Act Release No. 60405 (July 30, 
2009), 74 FR 39362 (August 6, 2009) Options Linkage Plan at Section 
5(b)(viii), which prohibits trading through a better price of 
another exchange unless an exception applies. Phlx Rule 
1084(b)(viii) provides an exception for complex orders. This 
exception applies to Complex Orders executed as such, and not those 
executed by legging, such as pursuant to Rule 1080.08(e)(vi)(A).
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    In addition to trade-through provisions, whether a Complex Order 
has a conforming ratio is also relevant in determining how the 
Exchange's spread priority rules apply. Today, Rule 1033(d) applies to 
executions of Complex Orders.\22\ Throughout Rule 1080.08, there are 
cross references to Rule 1033(d), which will now be deleted and 
replaced with new paragraph (c)(iii), which is the spread priority 
provision applicable to Complex Orders executed on Phlx XL II. The 
spread priority provisions in new subparagraph (c)(iii) provide the 
same priority under the same conditions to a broader class of Complex 
Orders under this proposal.
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    \22\ Exchange Rule 1033(d) affords priority to spread type 
orders over either the bid or the offer established in the 
marketplace that is not better than the bids or offers comprising 
such total credit or debit, provided that, the member executes at 
least one option leg at a better price than established bid or offer 
for that option contract AND no option leg is executed at a price 
outside of the established bid or offer for that option contract.
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    Spread priority refers to the priority of orders and quotes on the 
Exchange's own market and permits part of an eligible Complex Order to 
have priority over other bids and offers in the marketplace. Today, for 
a Complex Order consisting of two options components, if the ratio 
between those options components is a permissible (now called 
conforming) ratio, then if one option ``leg'' or component improves the 
Exchange's market for that option series, then the other option leg can 
be executed with priority over existing bids/offers (including 
customers), provided that neither option leg is executed at a price 
outside of the established bid or offer for that option contract.\23\ 
For example, if a Complex Order is received to buy one option A 
contract and sell one option B contract for a net debit of .65, where 
option A has a PBBO of 1.00-1.20 with a 1.00 customer limit order to 
buy on the book and option B has a PBBO of .45-.50 with a .50 customer 
limit order to sell on the book, permissible trade prices could be 1.15 
for option A and .50 for option B. Option B is allowed to execute at 
.50 because option A executed at a price that improved the Exchange's 
market in that option. The application of spread priority to Complex 
Orders consisting only of options is not changing and will now be 
covered by new Rule 1080.08(c)(iii)(A).
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    \23\ This applies to both trading in the complex orders 
automated functionality as well as manual trading on the floor. See 
Rule 1033(d).
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    Furthermore, under this proposal, because Complex Orders with a 
stock

[[Page 78323]]

component will now be permitted on Phlx XL II, priority provisions 
similar to Rule 1033 will now also apply to Complex Orders on Phlx XL 
II where one component is the underlying stock or ETF. Today, this is 
true for Complex Orders with a stock component executed manually on the 
trading floor, which are subject to Rule 1033(e). Thus, new 
subparagraph (c)(iii)(B) will govern the execution priority of the new 
stock-option Complex Orders on Phlx XL II. Specifically, it provides 
that where a conforming Complex Order consists of the underlying stock 
or ETF and one options leg, such options leg does not have priority 
over bids and offers established in the marketplace, including customer 
orders. Where a conforming Complex Order consists of the underlying 
stock or ETF and more than one options leg, the options legs have 
priority over bids and offers established in the marketplace, including 
customer orders, if at least one options leg improves the existing 
market for that option.
    For example, where there is a conforming Complex Order to buy 1 
option A, sell 1 option B, and sell 50 shares of the underlying stock 
for a net debit of 9.55 where the PBBO of option A is 1.00-1.20 with a 
customer 1.00 bid, the PBBO of option B is .40-.50, and the stock NBBO 
is 20.10-20.20, the following trade prices would be permissible: Option 
A could execute at 1.00, option B at .45, and the stock at 20.20. 
Option A is able to trade on the PBBO at the same price as the customer 
because option B improved the PBBO. The price of the stock portion is 
not relevant in applying the Exchange's option execution priority 
rules. As a second example, if a conforming Complex Order consists of 
only one option component and stock, then the option component may not 
be allowed to be executed at the same price as any existing bid/offer 
including customer bids/offers. For example, a conforming Complex Order 
to sell 1 option A and buy 100 shares, with option A having a PBBO of 
2.00-2.20 and the stock having a NBBO of 10.00-10.20, for a net debit 
of 7.90 could receive the following permissible trade prices: Option A 
could execute at 2.10 with the stock execution occurring at 10.00. 
Option A could not execute at 2.20, because the option component does 
not have priority over existing bids/offers.
Order Entry
    Currently, under subparagraph (b)(ii), Streaming Quote Traders 
(``SQTs''),\24\ Remote Streaming Quote Traders (``RSQTs''),\25\ non-SQT 
ROTs,\26\ specialists and non-Phlx market makers on another exchange 
are permitted to enter Complex Orders as IOC only. However, for Complex 
Orders consisting of more than two option components or where the 
underlying security is a component, SQTs, RSQTs, non-SQT ROTs, 
specialists and non-Phlx market makers on another exchange may also 
enter Day orders; \27\ once the Exchange has fully rolled out its 
enhanced Complex Order System, which will be announced in an Options 
Trader Alert, Day orders will become available for Complex Orders 
consisting of two option components. The Exchange expects that adding 
Day orders here should encourage more orders from this group of 
participants.
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    \24\ An SQT is a Registered Options Trader (``ROT'') who has 
received permission from the Exchange to generate and submit options 
quotations electronically through an electronic interface via an 
Exchange approved proprietary electronic quoting device in eligible 
options to which such SQT is assigned. See Rule 1014(b)(ii)(A).
    \25\ 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 options quotations 
electronically 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 Rule 1014(b)(ii)(B).
    \26\ A non-SQT ROT is an ROT who is neither an SQT nor an RSQT. 
See Rule 1014(b)(ii)(C).
    \27\ As a result of adding Day orders for this category of 
users, the Exchange also proposes to amend Rule 1080.08(f)(i) to 
eliminate reference to the types of orders on the Complex Limit 
Order Book, because it is too specific.
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    Currently, pursuant to subparagraph (b)(iii), Floor Brokers using 
the Options Floor Broker Management System may enter Complex Orders 
into the Exchange's electronic Complex Orders System as Day, GTC or IOC 
on behalf of non-broker-dealer customers and non-market maker off-floor 
broker-dealers, and as IOC only on behalf of broker-dealers or 
affiliates of broker-dealers. The Exchange proposes to amend this 
subparagraph to reflect that DNA orders and orders with more than two 
legs or a stock/ETF component (which are new) cannot be entered by 
Floor Brokers at this time. The Exchange believes that Floor Brokers 
are able to and use other, non-Exchange systems to access Phlx XL II, 
such that the FBMS, which is primarily intended to capture brokered 
orders into the options audit trail system, is not the sole method for 
them to submit orders to the Exchange. In addition, complex orders can 
be handled manually on the Exchange trading floor today. The Exchange 
believes that Floor Brokers are not likely to need or request these 
changes to FBMS, because they execute far more complex orders in the 
trading crowd today than through FBMS.
    Rule 1080.08(c) currently provides that a Complex Order is eligible 
to trade only when each component of the Complex Order is open for 
trading on the Exchange. The Exchange proposes to add the word 
``option'' in certain places in this provision, because one component 
of a Complex Order can now be the underlying security. The Exchange 
also proposes to require that the underlying security be open for 
trading on its primary market \28\ if such underlying security is a 
component of a Complex Order.
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    \28\ The Exchange intends to consider the primary market for the 
underlying security to be the listing market; if the Exchange 
determines to use a market other than the listing market, the 
Exchange will issue an Options Trader Alert announcing any such 
change.
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Complex Order Processing and Execution
    Currently, pursuant to Rule 1080.08(e)(i)(B)(2), a Complex Order 
that would otherwise be a COLA-eligible order that is received in the 
System during the final ten seconds of any trading session shall not be 
COLA-eligible. The Exchange proposes to make this time configurable, 
not to exceed the current ten seconds. The Exchange will issue an 
Options Trader Alert when the number of seconds changes.
    COLA-eligible orders, COLA Sweeps, and responsive Complex Orders 
trade first based on the best price or prices available at the end of 
the COLA Timer. If no COLA Sweeps or responsive Complex Orders for the 
same Complex Order Strategy as the COLA-eligible order that improve the 
initial cPBBO were received during the COLA Timer, each component of 
the COLA-eligible order may trade at the PBBO with existing quotes and/
or limit orders on the limit order book for the individual components 
of the Complex Order, provided that each component is executed such 
that the components comprise the Complex Order Strategy with the 
correct ratio for the desired net debit or credit. This is known as 
``legging,'' and the Exchange proposes to label subparagraph 
(e)(vi)(A)(1) as such. The Exchange is proposing to add that legging 
only occurs where there is no underlying security as a component of the 
Complex Order. If a COLA-eligible order cannot be filled in its 
entirety, any remaining balance would be placed on the CBOOK unless the 
COLA-eligible order has been submitted with other instructions (i.e., 
cancel).
    Currently, Complex Orders are automatically executed against orders 
on the CBOOK in price priority and in

[[Page 78324]]

time priority at the same price, as described in subparagraph (f)(iii). 
Specifically, a Complex Order resting on the CBOOK will execute 
automatically against: (i) Quotes or orders on the limit order book for 
the individual components of the order (allocated in accordance with 
Exchange Rule 1014(g)(vii), and an SQT or RSQT quoting on all 
components of the Complex Order will have priority over SQTs and RSQTs 
quoting a single component, but not over customer orders); or (ii) an 
incoming marketable Complex Order that does not trigger a COLA Timer, 
whichever arrives first. At this time, the Exchange proposes to delete 
the provision that an SQT or RSQT quoting on all components of the 
Complex Order will have priority over SQTs and RSQTs quoting a single 
component in order to simplify the allocation process as the Exchange 
begins to accept more Complex Order types. Instead, an SQT or RSQT 
quoting on all components of the Complex Order will be on parity with 
SQTs and RSQTs quoting a single component.\29\ This is being deleted 
from Rule 1080.08(e)(vi)(A)(1), (f)(iii)(A) and (f)(iii)(B)(1). The 
Exchange is deleting this provision to simplify system processing and 
does not believe, currently, that the benefits are material or being 
realized intentionally by participants. Furthermore, in Rule 
1080.08(f)(iii), the Exchange proposes to state that the execution 
against orders on the limit order book for the individual components 
means the options components, such that ``legging'' will not occur 
where any of the components is the underlying security.
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    \29\ This change will initially only apply to Complex Orders 
consisting of more than two options components or where the 
underlying stock/ETF is a component; once the Exchange has fully 
rolled out its enhanced Complex Order System, which will be 
announced in an Options Trader Alert, it will apply to Complex 
Orders consisting of two options components.
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    The Exchange proposes to add the word ``options'' in various places 
where the provision clearly applies only to the options component. For 
example, in subparagraph (c)(ii), most of the reasons why Complex 
Orders would not trade on the System relate to the options components. 
Similarly, in subparagraph (f)(i) governing what orders go on the 
CBOOK, ``options'' is being added to several of the provisions.
Underlying Stock/ETF Component
    In addition to making the various new references to the underlying 
stock/ETF as a component of a Complex Order, the Exchange also proposes 
to adopt new subparagraph (h), which will state that where one 
component of a Complex Order is the underlying stock/ETF, the Exchange 
shall electronically communicate the underlying stock/ETF component of 
a Complex Order to Nasdaq Options Services LLC (``NOS''), its 
designated broker-dealer, for execution; this occurs once the Phlx 
trading System determines that a Complex Order trade is possible and at 
what prices. Specifically, NOS will act as agent for such stock/ETF 
orders; NOS will match those orders, which always consist of both a buy 
and sell order for the stock/ETF, because the System has determined 
that two Complex Orders can trade with each other.\30\ NOS will match 
these orders not on an exchange, but rather ``over-the-counter.'' 
Accordingly, the Exchange proposes to permit NOS to perform this 
function, in addition to its approved routing functions.\31\
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    \30\ This is because Complex Orders consisting of the underlying 
stock or ETF can only trade with other Complex Orders. See proposed 
Rule 1080.08(a)(i), which reads as follows: Stock-option orders can 
only be executed against other stock-option orders and cannot be 
executed by the System against orders for the individual components.
    \31\ Securities Exchange Act Release Nos. 57478 (March 12, 
2008), 73 FR 14521 (March 18, 2008) (SR-NASDAQ-2007-004 and SR-
NASDAQ-2007-080); and 59995 (May 28, 2009), 74 FR 26750 (June 3, 
2009) (SR-Phlx-2009-32).
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    NOS is a broker-dealer and member of various exchanges and the 
Financial Industry Regulatory Authority (``FINRA''). As discussed in 
detail below, NOS, under this proposal, would be responsible for the 
proper execution, trade reporting and submission to clearing of the 
stock/ETF trade that is part of a Complex Order. Because these trades 
will occur off-exchange, the principal regulator is FINRA, rather than 
Phlx or NASDAQ. Furthermore, NOS is responsible for compliance with 
FINRA rules generally and is subject to examination by FINRA. 
Specifically, NOS is subject to NASD Rule 3010,\32\ which generally 
requires that the policies and procedures and supervisory systems be 
reasonably designed to achieve compliance with applicable securities 
laws and regulations and with applicable NASD and FINRA rules, 
including those relating to the misuse of material non-public 
information. To this end, NOS intends to have in place policies related 
to confidentiality and the potential for informational advantages 
relating to its affiliates, intended to protect against the misuse of 
material nonpublic information.\33\
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    \32\ FINRA was created in July 2007 through the consolidation of 
NASD and the member regulation, enforcement and arbitration 
functions of the NYSE. The FINRA rulebook currently consists of both 
NASD Rules and certain NYSE Rules that FINRA has incorporated 
(``Incorporated NYSE Rules'').
    \33\ Similarly, pursuant to Phlx Rule 1080(m)(iii)(C), the 
Exchange must establish and maintain procedures and internal 
controls reasonably designed to adequately restrict the flow of 
confidential and proprietary information between the Exchange and 
the Routing Facility.
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    In addition, because the execution and reporting of the stock/ETF 
piece will occur otherwise than on this Exchange or any other exchange, 
it will be handled by NOS pursuant to applicable rules regarding equity 
trading,\34\ including the rules governing trade reporting, trade 
throughs and short sales. Specifically, NOS will report the trades to 
the Trade Reporting Facility.\35\ Firms that are members of FINRA or 
the NASDAQ Stock Market (``NASDAQ'') are required to have a Uniform 
Service Bureau/Executing Broker Agreement (``AGU'') with NOS in order 
to trade Complex Orders containing a stock/ETF component. Firms that 
are not members of FINRA or NASDAQ are required to have a Qualified 
Special Representative (``QSR'') arrangement with NOS in order to trade 
Complex Orders containing a stock/ETF component. This requirement is 
codified in proposed Rule 1080.08(a)(i). Accordingly, this process is 
available to all Phlx member organizations and the stock/ETF component 
of a Complex Order, once executed, will be properly processed for trade 
reporting purposes.
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    \34\ See Securities Exchange Act Release No. 49023 (January 5, 
2004) (SR-ISE-2003-37) (``Once the orders are communicated to the 
broker-dealer for execution, the broker-dealer has complete 
responsibility for determining whether the orders may be executed in 
accordance with all of the rules applicable to execution of equity 
orders, * * *'').
    \35\ Specifically, the trades will be reported to the FINRA/
Nasdaq TRF, which is a facility of FINRA that is operated by The 
NASDAQ OMX Group, Inc. (``NASDAQ OMX'') and utilizes Automated 
Confirmation Transaction (``ACT'') Service technology. See e.g., 
Securities Exchange Act Release No. 61817 (March 31, 2010) (SR-
FINRA-2010-011).
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    With respect to trade throughs, the Exchange believes that the 
stock/ETF component of a Complex Order is eligible for the Qualified 
Contingent Trade Exemption from Rule 611(a) of Regulation NMS. A 
Qualified Contingent Trade is a transaction consisting of two or more 
component orders, executed as agent or principal, that satisfy the six 
elements in the Commission's order exempting Qualified Contingent 
Trades (``QCTs'') from the requirements of Rule 611(a),\36\ which 
requires trading centers to establish, maintain, and enforce written 
policies and procedures that are reasonably designed to prevent trade-

[[Page 78325]]

throughs.\37\ The Exchange believes that the stock/ETF portion of a 
Complex Order under this proposal complies with all six requirements. 
Moreover, as explained below, the Phlx trading System will validate 
compliance with each requirement such that any matched order received 
by NOS under this proposal has been checked for compliance with the 
exemption, as follows:
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    \36\ 17 CFR 242.611(a).
    \37\ See Securities Exchange Act Release No. 57620 (April 4, 
2008), 73 FR 19271 (April 9, 2008) (``QCT Release''). See also 
Securities Exchange Act Release No. 54389 (August 31, 2006), 71 FR 
52829 (September 7, 2006).
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    (1) At least one component order is in an NMS stock: The stock/ETF 
component must be an NMS stock, which is validated by the System;
    (2) all components are effected with a product or price contingency 
that either has been agreed to by the respective counterparties or 
arranged for by a broker-dealer as principal or agent: A Complex Order, 
by definition consists of a single net/debit price and this price 
contingency applies to all the components of the order, such that the 
stock price computed and sent to NOS allows the stock/ETF order to be 
executed at the proper net debit/credit price based on the execution 
price of each of the option legs, which is determined by the Phlx 
System;
    (3) the execution of one component is contingent upon the execution 
of all other components at or near the same time: Once a Complex Order 
is accepted and validated by the System, the entire package is 
processed as a single transaction and each of the option leg and stock/
ETF components are simultaneously processed;
    (4) the specific relationship between the component orders (e.g., 
the spread between the prices of the component orders) is determined at 
the time the contingent order is placed: Complex Orders, upon entry, 
must have a size for each component and a net debit/credit, which the 
System validates and processes to determine the ratio between the 
components; an order is rejected if the net debit/credit price and size 
are not provided on the order;
    (5) the component orders bear a derivative relationship to one 
another, represent different classes of shares of the same issuer, or 
involve the securities of participants in mergers or with intentions to 
merge that have been announced or since cancelled: under this proposal, 
the stock/ETF component must be the underlying security respecting the 
option legs, which is validated by the System; and
    (6) the transaction is fully hedged (without regard to any prior 
existing position) as a result of the other components of the 
contingent trade: Under this proposal, the ratio between the options 
and stock/ETF must be a conforming ratio (8 contracts per 100 shares), 
which the System validates, and which under reasonable risk valuation 
methodologies, means that the stock/ETF position is fully hedged.\38\
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    \38\ A trading center may demonstrate that an Exempted NMS Stock 
Transaction is fully hedged under the circumstances based on the use 
of reasonable risk-valuation methodologies. The release approving 
the original exemption stated: To effectively execute a contingent 
trade, its component orders must be executed in full or in ratio at 
its predetermined spread or ratio * * * ``In ratio'' clarifies that 
component orders of a contingent trade do not necessarily have to be 
executed in full, but any partial executions must be in a 
predetermined ratio.

Furthermore, proposed Rule 1080.08(a)(i) provides that member 
organizations may only submit Complex Orders with a stock/ETF component 
if such orders comply with the Qualified Contingent Trade Exemption. 
Member organizations submitting such Complex Orders with a stock/ETF 
component represent that such orders comply with the Qualified 
Contingent Trade Exemption.\39\ Thus, the Exchange believes that 
Complex Orders consisting of a stock/ETF component will comply with the 
exemption and that the Phlx trading System will validate such 
compliance to assist NOS in carrying out its responsibilities as agent 
for these orders.
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    \39\ See Amendment No. 1.
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    With respect to short sale regulation, the proposed handling of the 
stock/ETF component of a Complex Order under this proposal does not 
raise any issues of compliance with the currently operative provisions 
of Regulation SHO.\40\ When a Complex Order has a stock/ETF component, 
member organizations must indicate, pursuant to Regulation SHO, whether 
that order involves a long or short sale. The System will accept 
Complex Orders with a stock/ETF component marked to reflect either a 
long or short position; specifically, orders not marked as buy, sell or 
sell short will be rejected by the Phlx trading System. The Phlx 
trading System will electronically deliver the stock/ETF component to 
NOS for execution. Simultaneous to the options execution on the Phlx 
trading System, NOS will execute and report the stock/ETF component, 
which will contain the long or short indication as it was delivered by 
the member organization to the Phlx trading System. Accordingly, NOS, 
as a trading center under Rule 201, will be compliant with the 
requirements of Regulation SHO. Of course, broker-dealers, including 
both NOS and the member organizations submitting orders to the Phlx 
with a stock/ETF component, must comply with Regulation SHO; various 
surveillance and examination regulatory programs check for compliance 
thereto.
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    \40\ 17 CFR 242.200 et seq.
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    Earlier this year, the Commission amended Rule 201 and Rule 200(g) 
of Regulation SHO under the Act to adopt a short sale-related circuit 
breaker that, if triggered, imposes a restriction on the price at which 
securities may be sold short (``short sale price test restriction''); 
the amendments to Rule 200(g) provide that a broker-dealer may mark 
certain qualifying short sale orders ``short exempt.'' \41\ Recently, 
the Commission extended the compliance date for the amendments to Rule 
201 and Rule 200(g) until February 28, 2011.\42\ Once the new 
provisions of Regulation SHO become operative, NOS will accept orders 
marked ``short exempt.'' The Exchange intends to file a proposed rule 
change addressing the new provisions.
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    \41\ See Securities Exchange Act Release No. 61595 (February 26, 
2010), 75 FR 11232 (March 10, 2010) (``Rule 201 Adopting Release'').
    \42\ See Securities Exchange Act Release No. 63247 (November 4, 
2010), 75 FR 68702 (November 9, 2010) (File No. S7-08-09) (Order 
extending the compliance date until February 28, 2011).
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    For these reasons, the processing of the stock/ETF component of a 
Complex Order under this proposal will comply with applicable rules 
regarding equity trading, including the rules governing trade 
reporting, trade throughs and short sales. NOS' responsibilities 
respecting these equity trading rules will be documented in NOS' 
written policies and procedures. NOS compliance with these policies and 
procedures is monitored, reviewed, and updated as part of NOS' regular 
and routine regulatory program.
    As part of the execution of the stock/ETF component, the Exchange 
intends to ensure that the execution price is within the intraday high-
low range in that stock at the time the Complex Order is processed and 
within a certain price range from the current market, which the 
Exchange will establish in an Options Trader Alert. If the stock price 
is not within these parameters, the Complex Order is not executable.
    The Exchange believes that electronic submission of the stock/ETF 
piece of the Complex Order should help ensure that the Complex Order, 
as a whole, is executed timely and at the desired price.\43\ In 
addition, electronic communication eliminates the need for each party 
to separately manually submit the stock component to a broker-dealer 
for execution. The Exchange

[[Page 78326]]

emphasizes that the execution of the stock/ETF portion of a Complex 
Order will be immediate; the Exchange's System will calculate the stock 
price based on the net debit/credit price of the Complex Order,\44\ 
while also calculating and determining the appropriate options 
price(s), all electronically and immediately. The Exchange believes 
that this is a superior approach and would not require the Exchange to 
later nullify options trades if the stock price cannot be achieved. 
Accordingly, the Exchange is not proposing to adopt a rule permitting 
such option trade nullification, like other exchange rules, because the 
trade would not occur at a price that required later nullification due 
to the unavailability of the stock/ETF price.\45\ The Exchange further 
believes that the certainty associated with such electronic 
calculations and processing should be an attractive feature for users 
of Complex Orders with a stock or ETF component.
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    \43\ For a similar process, see ISE Rule 722.02.
    \44\ The stock/ETF price is, of course, included within the net 
debit/credit price of the Complex Order. See e.g. examples, infra, 
at 36.
    \45\ See e.g., ISE Rule 722.02 (A trade of a stock-option order 
will be automatically cancelled if market conditions prevent the 
execution of the stock or option leg(s) at the prices necessary to 
achieve the agreed upon net price.).
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    The Exchange also believes that it is appropriate to construct a 
program wherein its affiliate, NOS, is the exclusive conduit for the 
execution of the stock/ETF component of a Complex Order under this 
proposal, similar to the routing functionality of several options and 
equities exchanges.\46\ As a practical matter, complex order programs 
on other exchanges necessarily involve specific arrangements with a 
broker-dealer to facilitate prompt execution. NOS does not intend to 
charge a fee for the execution of the stock/ETF component of a Complex 
Order, nor does Phlx.\47\ The Exchange believes that is consistent with 
the Act for such an arrangement to involve one broker-dealer, even one 
that is an affiliate, particularly to offer the aforementioned benefits 
of a prompt, electronic execution for Complex Orders involving stock/
ETFs. Specifically, offering a seamless, automatic execution for both 
the options and stock/ETF components of a Complex Order is an important 
feature that should promote just and equitable principles of trade and 
remove impediments to and perfect the mechanism of a free and open 
market and a national market system by deeply enhancing the sort of 
complex order processing available on options exchanges today. 
Nevertheless, users of Phlx's proposed new Complex Orders system could, 
in lieu of this proposed arrangement with NOS, choose, instead, the 
following alternatives: (i) Avoid using Complex Orders that involve 
stock/ETFs, (ii) use the trading floor manual method of executing 
complex orders with stock, or (iii) go to another venue, several of 
which offer a similar feature, as described further below.
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    \46\ See also Phlx Rule 985(c)(1), which provides that The 
NASDAQ OMX Group, Inc., which owns NOS and the Exchange, shall 
establish and maintain procedures and internal controls reasonably 
designed to ensure that NOS does not develop or implement changes to 
its system on the basis of non-public information regarding planned 
changes to the Exchange's systems, obtained as a result of its 
affiliation with the Exchange, until such information is available 
generally to similarly situated Exchange members and member 
organizations in connection with the provision of inbound routing to 
the Exchange.
    \47\ However, Trade Reporting Facility and clearing fees, not 
charged by Phlx or NOS, may result. NSCC and ACT will bill firms 
directly for their use of the NSCC and ACT systems, respectively. To 
the extent that NOS is billed by NSCC or ACT, it will not pass 
through such fees to firms for the stock/ETF portion of a Complex 
Order under this proposal. Phlx's fees applicable to Complex Orders 
appear in its Fee Schedule and may change from time to time.
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2. Statutory Basis
    The Exchange believes that its proposal is consistent with Section 
6(b) of the Act \48\ in general, and furthers the objectives of Section 
6(b)(5) of the Act \49\ 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 enhancing its System and rules governing Complex Orders, 
by adding additional order types and components. These additional order 
types and components should provide market participants with trading 
opportunities more closely aligned with their investment or risk 
management strategies. Noting that complex orders, including those with 
a stock/ETF component are widely recognized and utilized by market 
participants, this proposal to offer new order types and components on 
an electronic system should provide a more efficient mechanism for 
carrying out these strategies.
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    \48\ 15 U.S.C. 78f(b).
    \49\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The proposed rule change does not impose any burden on competition 
not necessary or appropriate in furtherance of the purposes of the Act. 
Rather, this proposal enhances competition by providing an additional 
alternative to the existing methods of trading complex orders, 
including the stock/ETF component, in a single, seamless transaction. 
Member use of the Exchange's proposed Complex Order processing is 
entirely voluntary.
    The Exchange competes vigorously for complex orders among several 
options exchanges that offer a stock-option order type. The Exchange's 
proposed new alternative differs from and competes against existing 
Complex Order mechanisms by offering fully electronic processing. 
Existing Complex Order mechanisms at Chicago Board Options Exchange, 
Incorporated (``CBOE'') and International Securities Exchange, LLC 
(``ISE'') offer a similar end result--execution of paired option and 
stock orders--using different, less automated means.
    Market participants that prefer not to use the stock/ETF 
functionality offered herein through NOS have a variety of 
alternatives; stock-option orders can be executed on other options 
exchanges via various electronic methods, on various options trading 
floors or on the Exchange, without employing a stock/ETF component.
    Accordingly, in light of these various alternatives and the keen 
competition among options exchanges for complex order flow, the 
processing method selected by the Exchange, including the use of NOS, 
presents no burden on competition. In fact, the Exchange's proposal 
will likely promote competition for the most efficient means to execute 
complex orders with a stock/ETF component. The Exchange fully expects 
that other exchanges will mimic the proposed processing if it succeeds 
in attracting order flow for which many markets compete.

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

    No written comments were either solicited or received.

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

    Within 45 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the Exchange consents, the Commission shall: (a) By order approve 
or disapprove such proposed rule change, or (b) institute proceedings 
to determine whether the proposed rule change should be disapproved.

[[Page 78327]]

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change, as modified by Amendment No. 1, is consistent with the Act. 
Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an e-mail to rule-comments@sec.gov. Please include 
File Number SR-Phlx-2010-157 on the subject line.

Paper Comments

     Send paper comments in triplicate to Elizabeth M. Murphy, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-1090.

All submissions should refer to File Number SR-Phlx-2010-157. 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 website viewing and 
printing 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 the Exchange. 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-2010-157 and should be 
submitted on or before January 5, 2011.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\50\
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    \50\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. 2010-31487 Filed 12-14-10; 8:45 am]
BILLING CODE 8011-01-P