Self-Regulatory Organizations; Filing of Proposed Rule Change by the Philadelphia Stock Exchange, Inc. Relating to Adoption of a Customized Strike Facility for Foreign Currency Options

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-33959; International Series Release No. 660; File No.

SR-Phlx-94-11]

Self-Regulatory Organizations; Filing of Proposed Rule Change by

the Philadelphia Stock Exchange, Inc. Relating to Adoption of a

Customized Strike Facility for Foreign Currency Options

April 25, 1994.

Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934

(``Act''), 15 U.S.C. 78s(b)(1), notice is hereby given that on March 4,

1994, the Philadelphia Stock Exchange, Inc. (``Phlx'' or ``Exchange'')

filed with the Securities and Exchange Commission (``Commission'') the

proposed rule change as described in Items I, II, and III below, which

Items have been prepared by the Phlx.\1\ The Commission is publishing

this notice to solicit comments on the proposed rule change for

interested persons.

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\1\On March 22, 1994, the Exchange filed Amendment No. 1 to the

proposed rule change to specify that requests for quotes and

responsive quotes for customized strike options will be promptly

reported to the Options Price Reporting Authority and disseminated

as administrative text messages. See Letter from Michele Weisbaum,

Associate General Counsel, Phlx, to Michael Walinskas, Branch Chief,

Office of Derivatives and Equity Oversight (``ODEO''), Division of

Market Regulation (``Division''), Commission, dated March 22, 1994

(``Amendment No. 1''). On April 9, 1994, the Exchange filed

Amendment No. 2 to the proposed rule change to: (1) revise the

procedure in proposed Rule 1069(b) for executing a trade using

customized strike prices; and (2) provide that the quote spread

parameters for customized strike options will be twice those

provided in Phlx Rule 1014(c). See Letter from Michele Weisbaum,

Associate General Counsel, Phlx, to Michael Walinskas, Branch Chief,

ODEO, Division, Commission, dated April 8, 1994 (``Amendment No.

2'').

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I. Self-Regulatory Organization's Statement of the Terms of Substance

of the Proposed Rule Change

The Phlx, pursuant to Rule 19b-4 of the Act, proposes to adopt new

Rule 1069 to provide for the listing and trading of currency options

with customized strike prices. Rules 1002 and 1047, which address

exercise limits and trading rotations, respectively, are also being

amended accordingly. The text of the proposed rule change is available

at the Office of the Secretary, the Phlx, and at the Commission.

II. Self-Regulatory Organization's Statement of the Purpose of, and

Statutory Basis for, the Proposed Rule Change

In its filing with the Commission, the Phlx 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 Phlx 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 the

Statutory Basis for, the Proposed Rule Change

The Phlx states that the purpose of the filing is to adopt a

procedure whereby foreign currency option traders and their customers

will have the ability, within specified limits, to designate their own

option exercise price parameters on a trade. The Exchange now lists

specific series of options on foreign currencies that have exercises or

strike prices in set intervals at or near the spot price of the

underlying currency on which the options are traded. Users of the Phlx

foreign currency option market will now have the ability to trade

foreign currency options having a chosen exercise price, regardless of

whether it is a listed exercise price at the time. These options will

be called ``customized strike options.''

In the over-the-counter market, foreign currency options users

currently have the ability to designate the terms of such options with

respect to expiration date, exercise style, exercise price, and size.

The participants in that customized market are typically institutional

investors and banks, investors that often buy and sell options in large

size transactions. Users of the Phlx market, because of the selection

of expiration dates, strike prices, and exercise styles currently

listed on the Exchange, already have a significant ability to dictate

the terms of a foreign currency option contract. Once this new rule is

adopted, Phlx market participants will also be able to trade foreign

currency options with any chosen exercise price, regardless of whether

it is not one that has already been listed within the given parameters

set by the Phlx.

Customized strike options will be available for all currently

listed foreign currency options, including cross-rate options but

excluding cash-spot options. The customized strike option contracts may

also be either American or European-style and may have any expiration

date currently available for non-custom options, including long-term

options with terms up to three years out.\2\

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\2\The Phlx has received approval to trade long-term foreign

currency options with dates up to three years out. See Securities

Exchange Act Release No. 30672 (May 6, 1992), 57 FR 20546 (May 13,

1992). However, the Exchange is presently only listing options with

expirations as long as two years out and currently expects to only

trade customized strike options with expirations up to two years

out.

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By giving these institutional customers and banks the ability to

further customize options they wish to trade on an exchange, the Phlx

believes they will be able to better manage their risks and hedge their

portfolios, while receiving all of the protections and benefits an

organized exchange can provide. Also, by having the Options Clearing

Corporation (``OCC'') as the issuer and guarantor of the customized

strike options, the Phlx believes that concerns regarding contra-party

creditworthiness and option exercise performance are greatly reduced.

Finally, the Phlx believes that the real time dissemination of requests

for quotes, responsive quotes, and last sale information through the

Options Price Reporting Authority (``OPRA'') will help promote and

achieve market transparency in these options.

Customized strike options will be subject to all Exchange rules and

regulations regarding surveillance and sales practices. Unless

specifically exempted, all floor trading procedures will also be

adhered to. Examples of different procedures for customized strike

options include no continuous quoting, no opening or closing rotations,

and restrictions as to exercise.\3\ Examples of similar trading

practices include position limits and maximum quote spread parameters.

Position and exercise limits for customized strike options will be the

same as those provided for existing options on the same underlying

currency and positions in these options will be aggregated with

existing options in calculating position and exercise limits.

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\3\As proposed, the lesser of 100 contracts or the remaining

number of contracts may be exercised. See Amendment No. 2, supra

note 1.

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The Exchange believes that these options are better suited to large

institutional and bank traders rather than individuals and will

therefore tailor the product to such traders by requiring a minimum

size for any trade that may occur. Quotes may not be requested and

trades may not be executed in a series with no open interest for less

than 300 contracts. Responsive quotes to series with no open interest

must be at least 300 contracts for assigned ROTs and 100 contracts for

non-assigned ROTs. Responsive quotes and transactions in currently

opened series may be the lesser of 100 contracts or the remaining

number of contracts. Current methods of quoting will be used for these

options.

A 300 contract trade could have an underlying equivalent value of

approximately $12 million, depending on the specified currency. Because

of the relatively large size of the potential trades, the Exchange will

impose higher net capital requirements for ROTs trading in customized

strike options. Assigned ROTs will be subject to a $1 million minimum

net liquid assets requirement and all other ROTs will be subject to a

$250,000 minimum net liquid assets requirement. In accordance with

Exchange Rule 722, these options will be margined the same as regular

foreign currency options since the underlying currency and settlements

will be identical.

The proposed trade execution procedure is as follows.\4\ A

participant will come into the trading crowd and request a quote in a

customized strike option. The crowd will now have a standard time (as

described below) in which to submit responsive quotes. No trade may

occur until the expiration of the response period unless at least two

assigned ROTs have quoted a market. During the response time, existing

time priority and parity rules will apply in order to determine who

will participate on the contra-side of the order except that if an

assigned ROT has made a market and another participant betters the

market, the assigned ROT will have an opportunity to match that better

market if he voices that market prior to the execution of the trade.\5\

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\4\Id.

\5\Because, under the proposal, assigned ROTs would be required

to maintain higher net capital and make larger markets in unopened

series than unassigned ROTs, the Exchange believes that giving the

assigned ROTs this benefit will encourage ROTs to register for

assignments in the customized strike options and thereby provide

liquidity.

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The Foreign Currency Options Committee (``Committee'') has

determined that the response period should be a standard predefined

interval that may only change at the direction of the Committee and

with adequate notice to the membership and the Commission. Acceptable

time periods may be within the range of one to ten minutes and will be

set by the Committee prior to the start-up of trading in the customized

strike options. For example, the Committee may set the time period to

two minutes for all trades.

When a request for a quote is voiced in the trading crowd, it and

all responsive quotes will be displayed and reported to OPRA and

disseminated as an administrative text message over the OPRA System.\6\

Additionally, once a trade is consummated, it will also be reported to

OPRA and disseminated as an administrative text message over the OPRA

System. The specialist will not be obligated to make continuous markets

in customized options where open interest has been created. OCC will

clear and settle the options. Because quotes in these options will not

be continuously updated or otherwise priced by the Exchange, OCC will

generate a theoretical price based on the prices of currently listed

series and the closing value of the underlying foreign currency. OCC

will use this price to mark the options daily and calculate margin

requirements.

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\6\See Amendment No. 1, supra note 1.

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Acknowledging the consistent volatility of the foreign currency

market, the Phlx believes that customized strike options should bode

well for the investors speculating and hedging on the relative

performance of the various economies, as reflected by their currencies.

Finally, the quote spread parameters applicable to customized

strike options will be double the existing parameters for listed series

provided in Rule 1014.\7\ The Exchange believes the existing quote

spread parameters are too narrow for use with options such as these

which have customized features.\8\

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\7\See Amendment No. 2, supra note 1.

\8\Telephone conversation between Michele Weisbaum, Associate

General Counsel, Phlx, and Brad Ritter, Attorney, ODEO, Division,

Commission, on April 14, 1994.

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The Exchange believes that the foregoing rule change proposal is

consistent with Section 6 of the Act, in general, and with Section

6(b)(5), in particular, in that it is designed to promote just and

equitable principles of trade, foster cooperation and coordination with

persons engaged in regulating, clearing, settling, and processing

information, and facilitate transactions in securities, remove

impediments to and perfect the mechanism of a free and open market and

a national market system, and, in general, protect investors and the

public interest by providing foreign currency option market

participants with strike prices more closely suited to their trading

strategies.

(B) Self-Regulatory Organization's Statement on Burden on Competition

The Phlx does not believe that the proposed rule change will impose

any inappropriate burden on competition.

(C) Self-Regulatory Organization's Statement on Comments on the

Proposed Rule Change Received from Members, Participants or Others

No written comments were solicited or received with respect to the

proposed rule change.

III. Date of Effectiveness of the Proposed Rule Change and Timing

for Commission Action

Within 35 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 self-regulatory organization consents, the Commission

will:

(A) by order approve 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 inviting to submit written data, views and

arguments concerning the foregoing. Persons making written submissions

should file six copies thereof with the Secretary, Securities and

Exchange Commission, 450 Fifth Street, NW., Washington, DC 20549.

Copies of the submission, all subsequent amendments, all written

statements with respect to the proposed 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 Section, 450 Fifth Street, NW.,

Washington, DC. Copies of such filing will also be available for

inspection and copying at the principal office of the Phlx. All

submissions should refer to File No. SR-Phlx-94-11 and should be

submitted by May 23, 1994.

For the Commission, by the Division of Market Regulation,

pursuant to delegated authority.\9\

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\9\17 CFR 200.30(a)(12) (1993).

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Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 94-10395 Filed 4-29-94; 8:45 am]

BILLING CODE 8010-01-M