

[Federal Register: February 1, 2007 (Volume 72, Number 21)]
[Notices]               
[Page 4759-4761]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr01fe07-103]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-55156; File No. SR-NYSEArca-2006-73]

 
Self-Regulatory Organizations; NYSE Arca, Inc.; Order Granting 
Approval to Proposed Rule Change as Modified by Amendment No. 1 
Thereto, To Create an Options Penny Pilot Program

January 23, 2007.

I. Introduction

    On October 10, 2006, NYSE Arca, Inc. (``NYSE Arca'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``Commission''), pursuant to Section 19(b)(1) of the Securities 
Exchange Act of 1934 (``Act''),\1\ and Rule 19b-4 thereunder,\2\ a 
proposed rule change to amend the NYSE Arca Rules to permit certain 
option classes to be quoted in pennies on a pilot basis and to adopt a 
quote mitigation strategy. The proposed rule change was published for 
comment in the Federal Register on October 18, 2006.\3\ The Commission 
received three comment letters on the proposed rule change.\4\ On 
December 1, 2006, the Exchange filed Amendment No. 1 to the proposed 
rule change.\5\ The Exchange responded to the comment letters on 
January 9, 2007.\6\ This order approves the proposed rule change as 
modified by Amendment No. 1.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 54590 (October 12, 
2006), 71 FR 61525.
    \4\ See letters to Nancy M. Morris, Secretary, Commission, from 
Wayne Jervis, Managing Member of the General Partner, Jervis 
Alternative Asset Management Co. (``JAAMCO''), dated January 7, 2007 
(``JAAMCO Letter''); from Christopher Nagy, Chair, Securities 
Industry and Financial Markets Association (``SIFMA'') Options 
Committee, dated December 20, 2006 (``SIFMA Letter''); and from 
Peter J. Bottini, Executive Vice-President, optionsXpress, Inc. 
(``optionsXpress''), dated October 31, 2006 (``optionsXpress 
Letter'').
    \5\ Among other things, Amendment No. 1 proposed to replace 
Glamis Gold, which was delisted, with Agilent Tech, Inc. in the list 
of options classes permitted to be quoted in pennies. Amendment No. 
1 is technical in nature, and the Commission is not publishing 
Amendment No. 1 for public comment.
    \6\ See letter to Nancy M. Morris, Secretary, Commission, from 
Mary Yeager, Corporate Secretary, NYSE Arca, dated January 9, 2007 
(``Exchange Response'').
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II. Description of the Proposal

A. Scope of the Penny Pilot Program

    NYSE Arca proposes to amend its rules to permit certain options 
classes to be quoted in pennies during a six-month pilot (``Penny Pilot 
Program''), which would commence on January 26, 2007. Specifically, the 
Exchange proposes to (1) clarify the language in NYSE Arca Rule 6.72, 
which sets forth the minimum increments for options quoted on the 
Exchange; (2) add a reference in Rule 6.72 to the Penny Pilot Program; 
and (3) provide for an approved quote mitigation exception to NYSE Arca 
Rule 6.86.
    Currently, all six options exchanges, including NYSE Arca, quote 
options in nickel and dime increments. The minimum price variation for 
quotations in options series that are quoted at less than $3 per 
contract is $0.05 and the minimum price variation for quotations in 
options series that are quoted at $3 per contract or greater is $0.10. 
Under the Penny Pilot Program, beginning on January 26, 2007, market 
participants would be able to begin quoting in penny increments in 
certain series of option classes.
    The Penny Pilot Program would include the following thirteen 
options: Ishares Russell 2000 (IWM); NASDAQ-100 Index Tracking Stock 
(QQQQ); SemiConductor Holders Trust (SMH); General Electric Company 
(GE);

[[Page 4760]]

Advanced Micro Devices, Inc. (AMD), (Microsoft Corporation (MSFT); 
Intel Corporation (INTC); Caterpillar, Inc. (CAT); Whole Foods Market, 
Inc. (WFMI); Texas Instruments, Inc. (TXN); Flextronics International 
Ltd. (FLEX); Sun Microsystems, Inc. (SUNW); and Agilent Technologies, 
Inc. (A).
    The minimum price variation for all classes included in the Penny 
Pilot Program, except for the QQQQs, would be $0.01 for all quotations 
in option series that are quoted at less than $3 per contract and $0.05 
for all quotations in option series that are quoted at $3 per contract 
or greater. The QQQQs would be quoted in $0.01 increments for all 
options series.\7\
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    \7\ In Amendment No. 1, NYSE Arca requested that an additional 
option class be designated to quote and trade all series in pennies. 
In its comment letter, JAAMCO also expressed strong support for 
penny increments in all listed options. See JAAMCO Letter, supra 
note 4.
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    NYSE Arca commits to deliver a report to the Commission during the 
fourth month of the pilot, which would be composed of data from the 
first three months of trading. The report would analyze the impact of 
penny pricing on market quality and options system capacity.

B. Quote Mitigation Proposal

    NYSE Arca Rule 6.86 describes the obligations of the Exchange to 
collect, process and make available to quotation vendors the best bid 
and best offer for each option series that is a reported security. The 
Exchange proposes an exception to making quotes available to quotation 
vendors as part of an approved quote mitigation plan. The quote 
mitigation strategy proposed by the Exchange is intended to reduce the 
number of quotations generated by NYSE Arca for all option issues 
traded at NYSE Arca, not just issues included in the Penny Pilot 
Program. NYSE Arca plans to reduce the number of quote messages it 
sends to the Options Price Reporting Authority (``OPRA'') by only 
submitting quote messages for ``active'' options series. Active options 
series will be defined as: (i) The series has traded on any options 
exchange in the previous 14 calendar days; (ii) the series is solely 
listed on NYSE Arca; (iii) the series has been trading ten days or 
less; or (iv) the Exchange has an order in the series. For any option 
series that falls into one of the aforementioned categories, NYSE Arca 
will submit quotes to OPRA as it currently does. For any options series 
that falls outside of the above categories, NYSE Arca will still accept 
quotes from OTP Holders in these series; however, such quotes will not 
be disseminated to OPRA.
    In addition, under the proposal, there are certain instances when a 
series would become active intraday. This would occur if: (i) The 
series trades at any options exchange; (ii) NYSE Arca receives an order 
in the series; or (iii) NYSE Arca receives a request for quote from a 
customer in that series. When one of the above circumstances exists, 
NYSE Arca would immediately begin disseminating quotes to OPRA in that 
particular series and would continue doing so until that series fell 
outside of the active series definition. If the series does not trade, 
and there are no orders in the series the next day, the series would no 
longer be considered active.
    Finally, because NYSE Arca will continue to collect quotes from OTP 
Holders in inactive series, upon receiving an order in an inactive 
series, the Exchange will either execute that order against any 
marketable quotes in the trading system, or will link that order to the 
away market displaying the NBBO in that series. Accordingly, OTP 
Holders' orders will not be disadvantaged and will still have an 
opportunity to execute at the best price in such inactive series. By 
limiting quote dissemination to solely active series as described 
above, the Exchange anticipates that it will reduce quote message 
traffic by 20-30%.

III. Discussion

    After careful review of the proposal, the comment letters, and the 
Exchange's response thereto, the Commission finds that the proposed 
rule change, as modified by Amendment No. 1, is consistent with the 
requirements of the Act and the rules and regulations thereunder 
applicable to a national securities exchange.\8\ In particular, the 
Commission finds that the proposal is consistent with Section 6(b)(5) 
of the Act,\9\ which requires, among other things, that the rules of an 
exchange be 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.
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    \8\ In approving this proposed rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. See 15 U.S.C. 78c(f).
    \9\ 15 U.S.C. 78f(b)(5).
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    The Commission believes that the implementation of a limited six-
month Penny Pilot Program by NYSE Arca and the five other options 
exchanges will provide valuable information to the exchanges, the 
Commission and others about the impact of penny quoting in the options 
market. In particular, the Penny Pilot Program will allow analysis of 
the impact of penny quoting on: (1) Spreads; (2) transaction costs; (3) 
payment for order flow; and (4) quote message traffic.
    The Commission believes that the thirteen options classes to be 
included in the penny pilot program represent a diverse group of 
options classes with varied trading characteristics. This diversity 
should facilitate analyses by the Commission, the options exchanges and 
others. The Commission also believes that the Penny Pilot Program is 
sufficiently limited that it is unlikely to increase quote message 
traffic beyond the capacity of market participants' systems and disrupt 
the timely receipt of quote information.\10\ Nevertheless, because the 
Commission expects that the Penny Pilot Program will increase quote 
message traffic, the Commission is also approving the Exchange's 
proposal to reduce the number of quotations it disseminates.
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    \10\ The Commission does not agree with the Exchange's 
recommendation to allow an additional options class to be quoted in 
pennies in all series at this time. The Commission believes that it 
is important to commence penny quoting in a measured manner so as 
not to exacerbate systems capacity constraints.
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    In this regard, two of the commenters expressed concern about NYSE 
Arca's proposed quote mitigation strategy.\11\ In particular, 
optionsXpress was concerned that removing quotes from the market will 
reduce transparency and thereby undermine investor opportunity. SIFMA 
also objected to NYSE Arca's quote mitigation proposal because it 
believes that ``going dark'' in certain less active series will reduce 
investment opportunities for investors and may impede growth in the 
options industry.
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    \11\ JAAMCO did not comment directly on NYSE Arca's proposal, 
but rather stated its strong support for penny increment options 
trading that ``(1) includes all listed options, (2) prohibits 
Internalization of order flow to the extent that it disadvantages 
the customer, (3) has pricing linked to all listed options 
exchanges, (4) does not exclude options above $3.00 in value, and 
(5) does not exclude illiquid/not-daily-traded options.'' JAAMCO 
Letter, supra note 4.
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    In addition, SIFMA recommended that all six of the option exchanges 
adopt a comprehensive and uniform quote mitigation strategy. In 
particular, SIFMA strongly supports the adoption of the ``holdback 
timer'' mitigation proposal as the most efficient means of reducing 
quotation traffic. SIFMA expressed concern that the lack of uniformity 
among the quote mitigation proposals adopted by the exchanges will 
impose a burden on member firms and cause confusion for market 
participants, especially retail investors.

[[Page 4761]]

    Although the Commission supports efforts to implement a uniform, 
industry-wide quote mitigation plan, it does not believe such efforts 
preclude individual exchanges from initiating their own quote 
mitigation strategies. The Exchange stated its belief that, ``by not 
burdening the marketplace with excessive quotes, in series that have 
proven to have little or no investor interest, the Exchange will have 
the ability to supply additional quoting activity where most needed, 
thereby creating liquidity and a more competitive marketplace, which in 
turn should provide increased opportunities for all investors.'' \12\ 
In addition, the Exchange clarified that it will continue to collect 
and process quotes from Exchange Market Makers and will publish a quote 
upon a trade at another market or upon receipt of an order in that 
series.
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    \12\ See Exchange Response, supra note 6.
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    The Commission believes that NYSE Arca's proposed quote mitigation 
strategy is consistent with the Act and that it is unlikely to lead to 
confusion among market participants. In this regard, the Commission 
notes that Exchanges do not currently quote the identical series and 
classes of options. Furthermore, the Exchange has committed to provide 
a thorough study of the impact that its quote mitigation plan has on, 
among other things, system capacity problems or other problems that 
arose related to the operation of the Penny Pilot Program. 
Consequently, the Commission believes there are sufficient safeguards 
in place to analyze and, if necessary, address any negative impact that 
may result from NYSE Arca's proposal to disseminate quotes only in 
``active options series'' as defined by Commentary .03 to NYSE Arca 
Rule 6.86.

IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\13\ that the proposed rule change (SR-NYSEArca-2006-73), as 
modified by Amendment No. 1, be, and hereby is, approved on a six-month 
pilot basis, which will commence on January 26, 2007.
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    \13\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\14\
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    \14\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. E7-1589 Filed 1-31-07; 8:45 am]

BILLING CODE 8011-01-P
