Daily Rules, Proposed Rules, and Notices of the Federal Government
The Exchange proposes to add Commentary .01 to Rule 934.3NY to allow hedging stock, security future or futures contract positions to be represented currently with option facilitations or solicitations in the Trading Crowd ("tied hedge" orders) based on a recently approved rule change of the Chicago Board Options Exchange ("CBOE").
In its filing with the Commission, the self-regulatory organization 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 those 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 parts of such statements.
The Exchange is proposing to add Commentary .01 to Rule 934.3NY to allow hedging stock, security future or futures contract positions to be represented currently with option facilitations or solicitations in the Trading Crowd ("tied hedge" orders), based on a recently approved rule change of the CBOE. Rule 934.3NY generally sets forth the procedures by which a floor broker may cross an order with a solicited contra-side order. Currently, transactions executed pursuant to Rule 934.3NY are subject to the restrictions of paragraph (c) of Rule 995NY, Prohibited Conduct, which prohibits trading based on knowledge of imminent undisclosed solicited transactions (commonly referred to as "anticipatory hedging").
By way of background, when Rule 934.3NY was adopted in 2009, the Exchange noted its belief that it is appropriate to permit solicitation between potential buyers and sellers of options in advance of the time they send actual orders to the trading crowd on the Exchange. The Exchange also noted that, if the orders that comprise a solicited transaction are not suitably exposed to the order interaction process on the Trading Floor, the execution of such orders would not be consistent with Exchange rules designed to promote order interaction in an open-outcry auction.
When Rule 995NY was adopted in 2009, the Exchange believed that maintaining the prohibition on anticipatory hedging was necessary to prevent ATP Holders and associated persons from using undisclosed 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. NYSE Amex believes the basic principle remains true today, but changes in the marketplace have caused the Exchange to re-evaluate the effectiveness and efficiency of the existing rule's procedural requirements. The Exchange believes that increased volatility in the markets, as well as the advent of penny trading in underlying
In order to address the concerns associated with increased volatility and decreased liquidity and more effectively compete with the OTC market, the Exchange is proposing to adopt a limited exception to the anticipatory hedging restrictions that would permit the representation of hedging stock positions in conjunction with option orders, including complex orders, in the options trading crowd (a "tied hedge" transaction). The Exchange believes this limited exception remains in keeping with the original design of Rule 934.3NY, but sets forth a more practicable approach considering today's trading environment that will provide the ability to hedge in a way that will still encourage meaningful competition among upstairs and floor brokers. Besides stock positions, the proposal would also permit security futures positions to be used as a hedge. In addition, in the case where the order is for options on indices, options on exchange-traded funds ("ETF") or a related instrument may be used as a hedge. A "related instrument" would mean, in reference to an index option, securities comprising ten percent or more of the component securities in the index or a futures contract on any economically equivalent index applicable to the option order. A "related instrument" would mean, in reference to an ETF, a futures contract on any economically equivalent index applicable to the ETF underlying the option order.
With a tied hedge transaction, Exchange ATP Holders would be permitted to first hedge an option order with the underlying security, a security future or futures contract, as applicable, and then forward the option order and the hedging position to an Exchange floor broker with instructions to represent the option order together with the hedging position to the options trading crowd. The in-crowd market participants that chose to participate in the option transaction must also participate in the hedging position. First, under the proposal, the original option order must be in a class designated as eligible for a tied hedge transaction as determined by the Exchange, including FLEX Options classes.
Second, the proposal would require that, prior to entering tied hedge orders on behalf of customers, the ATP Holder must deliver to the customer a one-time written notification informing the customer that their order may be executed using the Exchange's tied hedge procedures. Under the proposal, the written notification must disclose the terms and conditions contained in the proposed rule and be in a form approved by the Exchange. Given the minimum size requirement of 500 contracts per order, the Exchange believes that use of the tied hedges procedures will generally consist of orders for the accounts of institutional or sophisticated, high net worth investors. The Exchange therefore believes that a one-time notification delivered by the ATP Holder to the customer would be sufficient, and that
Third, an ATP Holder would be required to create an electronic record that it is engaging in a tied hedge order in a form and manner prescribed by the Exchange. The Exchange states that the purpose of this provision is to create a record to ensure that hedging trades would be appropriately associated with the related options order and appropriately evaluated in the Exchange's surveillance program. The Exchange believes that this requirement should enable the Exchange to monitor for compliance with the requirements of the proposed rule, as discussed below, by identifying the specific purchase or sell orders relating to the hedging position.
Fourth, the proposed rule would require that ATP Holders that have decided to engage in tied hedge orders for representation in the trading crowd would have to ensure that the hedging position associated with the tied hedge order is comprised of a position that is designated as eligible for a tied hedge transaction. Eligible hedging positions would be determined by the Exchange for each eligible class and may include (i) the same underlying stock applicable to the options order, (ii) a security future overlying the same stock applicable to the option order, or (iii) in reference to an option on an index or an ETF, a "related instrument" (as described above). For example, for options overlying XYZ stock, the Exchange may determine to designate the underlying XYZ stock or XYZ security futures or both as eligible hedging positions.
The Exchange states that the purpose of this provision is to ensure that the hedging position would be for the same stock, equivalent security future or related instrument, as applicable, thus allowing crowd participants who may be considering participation in a tied hedge order to adequately evaluate the risk associated with the option as it relates to the hedge. With stock positions in particular, the Exchange notes that occasionally crowd participants hedge option positions with stock that is related to the option, such as the stock of an issuer in the same industry, but not the actual stock associated with the option. Except as otherwise discussed above for index options, the proposed rule change would not allow such a "related" hedging stock position, but would require the hedging stock position to be the actual security underlying the option.
Fifth, the proposal would require that the entire hedging position be brought without undue delay to the trading crowd. In considering whether the hedging position is presented without "undue delay," the Exchange believes that ATP Holders should continue to have the same ability to shop an order in advance of presenting it to the crowd and should be able to enhance that process through obtaining a hedge. The Exchange also believes that, once a hedge is obtained, the order should be brought to the crowd promptly in order to satisfy the "undue delay" requirement. In addition, the proposal would require that the hedging position be announced to the Trading Crowd concurrently with the options order, offered to the crowd in its entirety, and offered at the execution price received by the ATP Holder introducing the order to any in-crowd market participant who has established parity or priority for the related options. In-crowd market participants that participate in the option transaction must also participate in the hedging position on a proportionate basis
For example, if an ATP Holder introducing a tied stock hedge order were to offer 1,000 XYZ option contracts to the crowd (overlying 100,000 shares of XYZ stock) and concurrently offer only 30,000 of 100,000 shares of the underlying stock that the ATP Holder obtained as a hedge, crowd participants might only be willing or able to participate in 300 of the option contracts offered if the hedging stock position cannot be obtained at a price as favorable as the stock hedging position offering price, if at all. The Exchange states that the effect of this would be to place the crowd at a disadvantage relative to the introducing ATP Holder for the remaining 700 option contracts in the tied stock hedge order, and thus create a disincentive for the crowd to bid or offer competitively for the remaining 700 option contracts. The Exchange believes the requirement that the hedging position be presented concurrently with the option order in the crowd and offered to the crowd in its entirety at the execution price received by the ATP Holder introducing the order should ensure that the crowd would be competing on a level playing field with the introducing ATP Holder to provide the best price to the customer.
Sixth, the proposal would require that the hedging position not exceed the options order on a delta basis. For example, in the situation where a tied stock hedge order involves the simultaneous purchase of 50,000 shares of XYZ stock and the sale of 500 XYZ call contract (known as a "buy-write"), and the delta of the option is 100, it would be considered "hedged" by 50,000 shares of stock. Accordingly, the proposed rule would not allow the introducing ATP Holder firm to purchase more than 50,000 shares of stock in the hedging stock position. The Exchange believes that it is reasonable to require that the hedging position be in amounts that do not exceed the equivalent size of the related options order on a delta basis, and not for a greater number of shares. The Exchange believes that the proposed rule change would support its view that the ATP Holder introducing the tied hedge order be guided by the notion that any excess hedging activity could be detrimental to the eventual execution price of the option order. Consequently, while delta estimates may vary slightly, the introducing ATP Holder would be required to assume hedging positions not to exceed the equivalent size of the options order on a delta basis.
The Exchange believes that the delta basis requirement, together with the additional conditions that an introducing ATP Holder bring the hedging position without undue delay to the trading crowd and announce it concurrently with the option order, offer it to the crowd in its entirety, and offer it at the execution price received by the ATP Holder or to any in-crowd market participant who has established parity or priority, will help assure that the hedging activity is bona fide and not for speculative or manipulative purposes. Additionally, the Exchange believes these conditions will help assure that there is no adverse affect on the auction market because, as discussed above, in-crowd market participants will have the same opportunity as the ATP Holder introducing the tied hedge order to compete for the option order and will share the same benefits of limiting the market risk associated with hedging. The Exchange believes that customers will also benefit if the market risks are limited in the manner proposed. Once an original order is hedged, there is no delta risk. With the delta risk minimized, quotes will likely narrow as market participants (whether upstairs or on-floor) are better able to hedge and compete for orders. For example, Market-Makers could more easily quote markets to trade against a customer's original order based on volatility with the delta risk minimized, which would ultimately present more price improvement opportunities to the original order.
At this time, the Exchange is not proposing any special priority provisions applicable to tied hedge transactions, though it intends to evaluate whether such changes are desired and may submit a separate rule filing on this subject in the future. Under the instant proposal, all tied hedge transactions will be treated as Complex Orders (regardless of whether the original order was a simple or complex order). Priority will be afforded in accordance with the Exchange's existing open outcry allocation and reporting procedures for Complex Orders.
The Exchange recognizes that, at the time a tied hedge transaction is executed in a Trading Crowd, market conditions in any of the non-options market(s) may prevent the execution of the non-options leg(s) at the price(s) agreed upon. For example, the execution price may be outside the non-options market's best bid or offer ("BBO"),
The following examples illustrate these priority principles:
In either the simple or complex order scenario, the next steps are the same and are no different from the procedures currently used to execute a Complex Order on NYSE Amex in open outcry.
* The in-crowd market participants would have an opportunity to provide competing quotes for the tied hedge package (and not for the individual component legs of the package). For example, assume the best net price is $24.53 (equal to $0.50 for each option contract and $25.03 for each corresponding share of hedging stock).
* The option order and hedging stock would be allocated among the in-crowd market participants that established priority or parity at that price, including the initiating ATP Holder, in accordance with the standard allocation procedures, with the options leg being executed and reported on NYSE Amex and the stock leg being executed and reported on the stock market specified by the initiating ATP Holder.
For example, the introducing member might trade 40% pursuant to an open outcry crossing entitlement (200 options contracts and 20,000 shares of stock) and the remaining balance might be with three different Market-Makers that each participated on 20% of the order (100 options contracts and 10,000 shares of stock per Market-Maker).
* The execution of the options leg would have to satisfy the Exchange's intra-market priority rules for Complex Orders (including that the execution price may not be outside the NYSE Amex BBO). Thus, if the Exchange's BBO for the series was $0.40-$0.55, the execution could take place at or inside that price range (
* Similarly, the execution of the stock at $25.03 per share would have to satisfy the intra-market priority rules of the market(s) where the stock is to be executed (including that the execution price may not be outside that market's BBO) or, alternatively, qualify for an exception that permits the trade to be reported outside the executing market(s)' BBO.
* If market conditions in the executing market(s) prevent the execution of the stock leg(s) at the price(s) agreed upon from occurring (
While the particular circumstances surrounding each transaction on the Exchange's trading floor are different, the Exchange does not believe, as a general proposition, that the tied hedge procedures would be inherently harmful or detrimental to customers or have an adverse affect on the auction market. Rather, the Exchange believes the procedures will improve the opportunities for an order to be exposed to a competitive auction and represent an improvement over the current rules. The fact that the parties to such a trade end up fully hedged may contribute to the best execution of the orders and, in any event, participants continue to be governed by, among other things, their best execution responsibilities. The Exchange also believes that the proposed tied hedge procedures are fully consistent with the original design of Rule 995(c)NY, which, as discussed above, was designed to eliminate the unfairness that can be associated with a solicited transaction and to encourage meaningful competition. The tied hedge procedures will keep in-crowd market participants on equal footing with solicited parties in a manner that minimizes all parties' market risk while continuing to assure that orders are exposed in a meaningful way.
The Exchange believes the proposed rule change is consistent with Section 6(b) of the Act
The Exchange does not believe that the proposed rule change will impose any burden on competition that is not necessary or appropriate in furtherance of the purposes of the Act.
No written comments were solicited or received with respect to the proposed rule change.
The Exchange has filed the proposed rule change pursuant to Section 19(b)(3)(A)(iii) of the Act
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 furtherance of the purposes of the Act.
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:
* Use the Commission's Internet comment form (
* Send an e-mail to
* Send paper comments in triplicate to Elizabeth M. Murphy, Secretary, Securities and Exchange Commission, 100 F Street, NE., Washington, DC 20549-1090.