83 FR 40797 - Self-Regulatory Organizations; Nasdaq PHLX LLC; Notice of Filing of Proposed Rule Change Relating to Anticipatory Hedging

SECURITIES AND EXCHANGE COMMISSION

Federal Register Volume 83, Issue 159 (August 16, 2018)

[Federal Register Volume 83, Number 159 (Thursday, August 16, 2018)]
[Notices]
[Pages 40797-40800]
From the Federal Register Online  [www.thefederalregister.org]
[FR Doc No: 2018-17633]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-83826; File No. SR-Phlx-2018-55]


Self-Regulatory Organizations; Nasdaq PHLX LLC; Notice of Filing 
of Proposed Rule Change Relating to Anticipatory Hedging

August 10, 2018.
    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 August 3, 2018, Nasdaq 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. 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 proposes to amend Rule 1064(d) related to Anticipatory 
Hedging.
    The text of the proposed rule change is available on the Exchange's 
website at http://nasdaqphlx.cchwallstreet.com/, at the principal 
office of the Exchange, and at the Commission's Public Reference Room.

[[Page 40798]]

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 proposes to amend Rule 1064 entitled ``Crossing, 
Facilitation and Solicited Orders.'' Specifically, the Exchange 
proposes to amend 1064(d)(iii)(A) to add a specific eligibility size 
when transacting options on the Nasdaq 100[supreg] Index including 
options with nonstandard expiration dates \3\ (``NDX'' and ``NDXP''). 
The Exchange also proposes to amend an incorrect cross-reference to 
Rule 1064 and replace certain references with a defined term.
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    \3\ NDX represents A.M.-settled options on the Nasdaq 100 
[supreg] Index. NDXP represent P.M.-settled options on the Nasdaq 
100 [supreg] Index.
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    Rule 1064(d) describes rules for anticipatory hedging on Phlx. The 
rule provides:

no member organization or person associated with a member or member 
organization who has knowledge of the material terms and conditions 
of a solicited order, an order being facilitated, or orders being 
crossed, the execution of which are imminent, shall enter, based on 
such knowledge, an order to buy or sell an option for the same 
underlying security; an order to buy or sell the security underlying 
such class; or an order to buy or sell any related instrument until 
(i) or (ii) occur: (i) the terms and conditions of the order and any 
changes in the terms of the order of which the member, member 
organization or person associated with a member or member 
organization has knowledge are disclosed to the trading crowd, or 
(ii) the trade can no longer reasonably be considered imminent in 
view of the passage of time since the order was received. For 
purposes of this Rule, an order to buy or sell a ``related 
instrument'' means, in reference to an index option, an order to buy 
or sell securities comprising 10% or more of the component 
securities in the index or an order to buy or sell a futures 
contract on an economically equivalent index.

    Among other conditions, Rule 1064(d)(iii) provides that it does not 
prohibit a member or member organization from buying or selling a 
stock, security futures or futures position following receipt of an 
option order, including a complex order, but prior to announcing such 
order to the trading crowd, provided that the option order is in a 
class designated as eligible for ``tied hedge'' transactions \4\ as 
determined by the Exchange and is within the designated tied hedge 
eligibility size parameters, which parameters shall be determined by 
the Exchange and may not be smaller than 500 contracts per order (there 
shall be no aggregation of multiple orders to satisfy the size 
parameter).
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    \4\ A tied hedge transaction is described in Rule 
1064(d)(iii)(C)-(H).
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    When Phlx originally adopted the anticipatory hedge rule in 
2001,\5\ the Exchange believed that the prohibition on anticipatory 
hedging was necessary to prevent members and associated persons from 
using undisclosed non-public information about imminent solicited 
option transactions to trade the relevant option or any closely-related 
instrument in advance of persons represented in the relevant options 
crowd. The Exchange notes that the tied-hedge exception was designed to 
preserve the right to cross orders in advance of submitting a proposal 
to the trading crowd, while at the same time assuring that orders that 
are the subject of crossing are exposed to the auction market (trading 
crowd) in a meaningful way by prohibiting behavior such as anticipatory 
hedging.\6\
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    \5\ See Securities Exchange Act Release No. 44740 (August 23, 
2001), 66 FR 45721 (August 29, 2001) (SR-Phlx-2001-61).
    \6\ See Securities Exchange Act Release No. 61066 (November 25, 
2009), 74 FR 63162 (December 2, 2009) (SR-Phlx-2009-98).
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    The Exchange notes that the primary purpose of the provision, ``not 
smaller than 500 contracts'' is to limit use of the tied hedge 
procedures to larger orders that might benefit from a member's or 
member organization's ability to execute a facilitating hedge.\7\ When 
adopting the tied hedge exception the Exchange stated that it believes 
that, given the decreased amount of liquidity available at the NBBO, 
the frequency with which quotes may flicker, and differing costs 
associated with accessing liquidity on various markets, as well as for 
ease of administration, the proposed 500 contract minimum should be 
sufficient to address these considerations.\8\
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    \7\ Id.
    \8\ Id.
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    The Exchange is proposing to add an exception to the eligibility 
size parameters for options on the Nasdaq 100[supreg] Index including 
options with nonstandard expiration dates (``NDX'' and ``NDXP'') which 
lowers the size eligibility for this index to not smaller than 50 
contracts per order. The Exchange believes that this smaller order 
eligibility size is appropriate for NDX and NDXP because the index 
value for NDX and NDXP is high as compared to other securities 
instruments. An index has a multiplier of 100. The Exchange believes 
that lowering the eligibility size for NDX and NDXP from 500 to 50 
contracts is appropriate because it would reduce the minimal notional 
value of the trade.
    For example NDX, as of July 19, 2018, had an Index Level of 7,356 
and factoring in the contract multiplyer of 100 provides a notional 
value of $735,600 as compared to PowerShares QQQ (``QQQ'') which had an 
equity value of 179.03 with a notional value of $17,903 (100 x 
underlying value) as of July 19, 2018. The premium value of NDX front 
month, at-the-money calls for August 17th midpoint was $130.35. 
Utilizing this value with 500 contracts would equate to a total premium 
for NDX of $6,517,500 and utilizing this value with 50 contracts would 
equate to a total premium for NDX of $651,750. By comparison, the 
premium value of QQQ front month, at-the-money calls for August 17th 
midpoint was $3.43. Utilizing this value with 500 contracts would 
equate to a total premium for QQQ of $171,500 and utilizing this value 
with 50 contracts would equate to a total premium for QQQ of $17,150. 
The example demonstrates the much larger size of NDX as compared to 
QQQ, a highly liquidity equity option. This example reflects the size 
comparison against a large broad based index and demonstrates the size 
of NDX.
    The Exchange notes that this smaller size carve out for NDX is in 
line with the original intent of the selection of the size of the 
contracts, to limit use of the tied hedge procedures to larger orders 
that might benefit from a member's or member organization's ability to 
execute a facilitating hedge. The Exchange notes that a size of 50 
contracts for NDX is still considered a large size order given the 
higher notional value.
    The Exchange notes that it conducts certain surveillances in 
connection with anticipatory hedging. Specifically, the Exchange 
conducts an on-floor surveillance to ensure both the stock and option 
component parts of the trade were exposed in open outcry and there was 
a reasonable opportunity for the trading crowd to participant in the 
transaction. Further, post-trade surveillance is conducted with respect

[[Page 40799]]

to anticipatory hedging rules. The Exchange notes that pursuant to Phlx 
Rule 1064(d)(iii)(G), prior to entering tied hedge orders on behalf of 
customers, the member or member organization must deliver to the 
customer a written notification informing the customer that his order 
may be executed using the Exchange's tied hedge procedures. The written 
notification must disclose the terms and conditions contained herein 
and be in a form approved by the Exchange. The Exchange notes that tied 
hedge transactions does not occur with great frequency on the 
Exchange's trading floor.
Amend Cross Reference and Define Term
    The Exchange proposes to amend Rule 1066(f)(4) entitled ``Tied 
Hedge Order.'' Currently, the rule provides that a tied hedge order is 
an option order that is tied to a hedge transaction as defined in 
Commentary .04 to Rule 1064, following the receipt of an option order 
in a class determined by the Exchange as eligible for ``tied hedge'' 
transactions. The Exchange proposes to replace Commentary .04 to Rule 
1064 within Rule 1066(f)(4) to reference Rule 1064(d)(iii) to correct 
the cross-reference.
    The Exchange also proposes to replace legacy references to the 
Exchange's trading platform in Rule 1066, namely ``PHLX XL'' and ``PHLX 
XL II'' with the term ``System'' which was recently defined by the 
Exchange.\9\
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    \9\ System is defined in Phlx Rule 1000(b)(45).
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2. Statutory Basis
    The Exchange believes that its proposal is consistent with Section 
6(b) of the Act,\10\ in general, and furthers the objectives of Section 
6(b)(5) of the Act,\11\ 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 changing the size requirements to assist NDX and NDXP to 
meet the eligibility requirements for Rule 1064(d).
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    \10\ 15 U.S.C. 78f(b).
    \11\ 15 U.S.C. 78f(b)(5).
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    The Exchange's proposed amendment to Rule 1064(d) to permit lower 
size eligibility requirements for NDX and NDXP of not smaller than 50 
contracts per order is consistent with the Act and the protection of 
investors and the public interest because this smaller order 
eligibility size is appropriate for NDX and NDXP. NDX is a broad based 
index that is designed to reflect the movement of a large segment of 
the market. Each of these options represents a notional value equal to 
100 units of the index. NDX is a large-cap growth index with 105 
components. As with other broad based indexes, NDX has a large notional 
value as compared to non-index options. The index value for NDX and 
NDXP is 6400. Based on the index multiplier of 100, an index option 
would equate to 640,000 in notional value, which is high. The Exchange 
believes that lowering the eligibility size for NDX and NDXP from 500 
to 50 contracts is appropriate because it would reduce the notional 
value of one contract to 64,000 in notional value. The proposed rule 
would permit an eligibility size for NDX and NDXP that takes into 
account the notional value for this index. The Exchange believes that 
permitting the lower eligibility size for NDX and NDXP does not 
substantively amend the eligible order size, rather it provides a more 
appropriate mathematical equivalent.
    The Exchange notes that this smaller size carve out for NDX is in 
line with the original intent of the selection of the size of the 
contracts, to limit use of the tied hedge procedures to larger orders 
that might benefit from a member's or member organization's ability to 
execute a facilitating hedge. The Exchange notes that a size of 50 
contracts for NDX is still considered a large size order and in fact, 
in the case of NDX, a larger size than 500 contracts for an option 
contract.
Amend Cross Reference and Define Term
    The Exchange's proposal to replace Commentary .04 to Rule 1064 with 
Rule 1064(d)(iii) to correct the cross-reference and replace ``PHLX 
XL'' and ``PHLX XL II'' with the term ``System'' are consistent with 
the Act because they will provide more clarity as to the Exchange's 
Rules. The Exchange also proposes to replace the words ``PHLX XL'' in 
the title of Phlx Rule 1066 with the newly defined term System. The 
term PHLX XL is the name of the Exchange's trading platform. The term 
``System'' is intended to define the electronic trading platform.

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. The Exchange believes that the 
proposed amendment to Rule 1064(d) to permit lower size eligibility 
requirements for NDX and NDXP will apply uniformly to all market 
participants. The Exchange notes that this smaller size carve out for 
NDX is in line with the original intent of the selection of the size of 
the contracts, to limit use of the tied hedge procedures to larger 
orders that might benefit from a member's or member organization's 
ability to execute a facilitating hedge. The Exchange's proposal to 
replace Commentary .04 to Rule 1064 with Rule 1064(d)(iii) to correct 
the cross-reference and replace ``PHLX XL'' and ``PHLX XL II'' with the 
term ``System'' are non-substantive rule changes. The Exchange does not 
believe that this will impact inter-market competition because the 
smaller eligibility size will permit NDX and NDXP to be available to 
market participants for a tied hedge similar to other competing index 
options.

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 up to 90 days (i) as the 
Commission may designate 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.

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

     Use the Commission's internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an email to [email protected]. Please include 
File Number SR-Phlx-2018-55 on the subject line.

Paper Comments

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


[[Page 40800]]


All submissions should refer to File Number SR-Phlx-2018-55. This file 
number should be included on the subject line if email 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 website (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 10:00 a.m. and 
3:00 p.m. Copies of the filing also will be available for inspection 
and copying at the principal office of the Exchange. All comments 
received will be posted without change. Persons submitting comments are 
cautioned that we do not redact or edit personal identifying 
information from comment submissions. You should submit only 
information that you wish to make available publicly. All submissions 
should refer to File Number SR-Phlx-2018-55 and should be submitted on 
or before September 6, 2018.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\12\
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    \12\ 17 CFR 200.30-3(a)(12).
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Robert W. Errett,
Deputy Secretary.
[FR Doc. 2018-17633 Filed 8-15-18; 8:45 am]
BILLING CODE 8011-01-P