
[Federal Register: February 29, 2008 (Volume 73, Number 41)]
[Notices]               
[Page 11178-11181]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr29fe08-131]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-57359; File No. SR-Phlx-2008-07]

 
Self-Regulatory Organizations; Philadelphia Stock Exchange, Inc.; 
Notice of Filing and Immediate Effectiveness of Proposed Rule Change To 
Create a Delta Hedging Exemption From Equity Options Position Limits

February 20, 2008.
    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 February 12, 2008, 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 and 
II below, which Items have been substantially prepared by Phlx. The 
Exchange has filed the proposal as a ``non-controversial'' rule change 
pursuant to Section 19(b)(3)(A) of the Act \3\ and Rule 19b-4(f)(6) 
thereunder,\4\ which renders it effective upon filing with the 
Commission. 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.
    \3\ 15 U.S.C. 78s(b)(3)(A).
    \4\ 17 CFR 240.19b-4(f)(6).
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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 Phlx Rule 1001 to establish a delta 
hedge exemption from equity options position limits.\5\ The text of the 
proposed rule change is available at Phlx, the Commission's Public 
Reference Room, and http://www.phlx.com.
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    \5\ The proposed filing is being done pursuant to an industry-
wide initiative, under the auspices of the Intermarket Surveillance 
Group (``ISG''), to establish comparable delta hedge exemption rules 
among exchanges. ISG is a regulatory information-sharing 
organization comprised of all U.S. national securities exchanges and 
national securities associations, most U.S. futures exchanges, and 
non-U.S. exchanges and associations trading securities and related 
products.
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II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, Phlx included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed

[[Page 11179]]

rule change. The text of these statements may be examined at the places 
specified in Item IV below. 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 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    The purpose of the proposed rule change is to permit expanded hedge 
positions pursuant to a carefully crafted delta hedge exemption from 
equity options position limits in Phlx Rule 1001.
    Background. All options traded on the Exchange are subject to 
position and exercise limits, as provided under Phlx Rules 1001 and 
1002, respectively.\6\ Position limits are imposed, generally, to 
maintain fair and orderly markets for options and other securities by 
limiting the amount of control one or more affiliated persons or 
entities may have over one particular options class or the security or 
securities that underlie that options class.
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    \6\ Position and exercise limits for index options are provided 
separately under Phlx Rules 1001A and 1002A.
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    Over the years, Phlx has increased the size of options position and 
exercise limits, as well as the size and scope of available hedge 
exemptions to the applicable position limits.\7\ These hedge exemptions 
generally require a one-to-one hedge (e.g., one stock option contract 
must be hedged by the number of shares underlying the options contract, 
typically 100 shares). In practice, however, many firms do not hedge 
their options positions in this manner. Instead, these firms engage in 
what is commonly known as ``delta hedging.'' Delta hedging varies the 
number of shares of the underlying security used to hedge an options 
position based upon the relative sensitivity of the value of the option 
contract to a change in the price of the underlying security.\8\ The 
Exchange believes that delta hedging is a widely accepted method for 
risk management.
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    \7\ See Securities Exchange Act Release Nos. 51071 (January 21, 
2005), 70 FR 4911 (January 31, 2005) (SR-Phlx-2005-05); 55285 
(February 13, 2007), 72 FR 8053 (February 22, 2007) (SR-Phlx-2007-
10); 45899 (May 9, 2002), 67 FR 34980 (May 16, 2002) (SR-Phlx-2002-
33); 42386 (February 4, 2000), 65 FR 6680 (February 10, 2000) (SR-
Phlx-98-55); and 40400 (September 3, 1998), 63 FR 48777 (September 
11, 1998) (SR-Phlx-98-36).
    \8\ To illustrate, a stock option contract with a delta of .5 
will move $0.50 for every $1.00 move in the underlying stock.
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    Delta Neutral-Based Equity Hedge Exemption. The Exchange proposes 
to adopt a new exemption from equity options position and exercise 
limits \9\ for positions held by Phlx members and certain of their 
affiliates that are ``delta neutral'' \10\ under a ``permitted pricing 
model'' (as defined below), subject to certain conditions 
(``Exemption''). The proposed Exemption would apply only to equity 
options (stock options and options on exchange-traded funds 
(``ETFs'')).\11\
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    \9\ Phlx Rule 1002 establishes exercise limits for an option at 
the same level as the option's position limit under Phlx Rule 1001; 
therefore, no changes are proposed to Rule 1002.
    \10\ The term ``delta neutral'' is defined in proposed 
Commentary .09(a) to Phlx Rule 1001 as referring to an equity option 
position that is hedged, in accordance with a permitted pricing 
model, by a position in the underlying security or one or more 
instruments relating to the underlying security, for the purpose of 
offsetting the risk that the value of the option position will 
change with incremental changes in the price of the security 
underlying the option position.
    \11\ The Exchange intends to submit a separate proposed rule 
change, in conjunction with an industry initiative, to adopt a delta 
neutral-based hedge exemption for certain index options and to 
expand the delta neutral-based hedge exemption for ETF options to 
allow highly correlated instruments to be included in any ETF option 
net delta calculation.
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    Any equity option position that is not delta neutral would be 
subject to position and exercise limits, subject to the availability of 
other exemptions. Only the ``option contract equivalent of the net 
delta'' of such position would be subject to the appropriate position 
limit.\12\
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    \12\ Under proposed Commentary .09(b) to Phlx Rule 1001, the 
term ``options contract equivalent of the net delta'' is defined as 
the net delta divided by the number of shares underlying the option 
contract, and the term ``net delta'' is defined as, at any time, the 
number of shares (either long or short) required to offset the risk 
that the value of an equity option position will change with 
incremental changes in the price of the security underlying the 
option position, as determined in accordance with a permitted 
pricing model.
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    Only financial instruments relating to the security underlying an 
equity options position could be included in any determination of an 
equity options position's net delta or whether the options position is 
delta neutral. In addition, members could not use the same equity or 
other financial instrument position in connection with more than one 
hedge exemption. Therefore, a stock position used as part of a delta 
hedging strategy could not also serve as the basis for any other equity 
hedge exemption.
    Permitted Pricing Model. Under the proposed rule, the calculation 
of the delta for any equity option position, and the determination of 
whether a particular equity option position is delta neutral, must be 
made using a permitted pricing model. A ``permitted pricing model'' is 
defined in proposed Commentary .09(c) to mean the pricing model 
maintained and operated by The Options Clearing Corporation (``OCC'') 
and the pricing models used by: (i) A member or its affiliate subject 
to consolidated supervision by the Commission pursuant to Appendix E of 
Rule 15c3-1 under the Act; (ii) a financial holding company (``FHC'') 
or a company treated as an FHC under the Bank Holding Company Act of 
1956, or its affiliate subject to consolidated holding company group 
supervision; \13\ (iii) a Commission-registered OTC derivatives dealer; 
\14\ and (iv) a national bank.\15\
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    \13\ The pricing model of an FHC or of an affiliate of an FHC 
would have to be consistent with: (i) The requirements of the Board 
of Governors of the Federal Reserve System (``Fed''), as amended 
from time to time, in connection with the calculation of risk-based 
adjustments to capital for market risk under capital requirements of 
the Fed, provided that the member or affiliate of a member relying 
on this exemption in connection with the use of such model is an 
entity that is part of such company's consolidated supervised 
holding company group; or (ii) the standards published by the Basel 
Committee on Banking Supervision, as amended from time to time and 
as implemented by such company's principal regulator, in connection 
with the calculation of risk-based deductions or adjustments to or 
allowances for the market risk capital requirements of such 
principal regulator applicable to such company--where ``principal 
regulator'' means a member of the Basel Committee on Banking 
Supervision that is the home country consolidated supervisor of such 
company--provided that the member or affiliate of a member relying 
on this exemption in connection with the use of such model is an 
entity that is part of such company's consolidated supervised 
holding company group. See proposed Commentary .09(c)(3) to Phlx 
Rule 1001.
    \14\ The pricing model of a Commission-registered OTC 
derivatives dealer would have to be consistent with the requirements 
of Appendix F to Rule 15c3-1 and Rule 15c3-4 under the Act, as 
amended from time to time, in connection with the calculation of 
risk-based deductions from capital for market risk thereunder. Only 
an OTC derivatives dealer and no other affiliated entity (including 
a member) would be able to rely on this part of the Exemption. See 
proposed Commentary. 09(c)(4) to Phlx Rule 1001.
    \15\ The pricing model of a national bank would have to be 
consistent with the requirements of the Office of the Comptroller of 
the Currency, as amended from time to time, in connection with the 
calculation of risk-based adjustments to capital for market risk 
under capital requirements of the Office of the Comptroller of the 
Currency. Only a national bank and no other affiliated entity 
(including a member) would be able to rely on this part of the 
Exemption. See proposed Commentary .09(c)(5) to Phlx Rule 1001.
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    Aggregation of Accounts. Members and non-member affiliates relying 
on the Exemption would be required to ensure that the permitted pricing 
model is applied to all positions in or relating to the security 
underlying the relevant options position that are owned or controlled 
by the member, or its affiliates.
    However, the net delta of an options position held by an entity 
entitled to rely on the Exemption, or by a separate

[[Page 11180]]

and distinct trading unit of such entity, may be calculated without 
regard to positions in or relating to the security underlying the 
option position held by an affiliated entity or by another trading unit 
within the same entity, provided that: (i) The entity demonstrates to 
the Exchange's satisfaction that no control relationship, as defined in 
Commentary .06 to Phlx Rule 1001, exists between such affiliates or 
trading units, and (ii) the entity has provided the Exchange written 
notice in advance that it intends to be considered separate and 
distinct from any affiliate, or, as applicable, which trading units 
within the entity are to be considered separate and distinct from each 
other for purposes of the Exemption.\16\
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    \16\ See proposed Commentary .09(d) to Phlx Rule 1001.
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    The Exchange has set forth, in Phlx Memorandum No. 0025-08 
(``Aggregation Memo''), the conditions under which it will deem no 
control relationship to exist between affiliated broker-dealers, and 
between separate and distinct trading units within the same broker-
dealer. Subsequent to this proposal the Exchange intends to update the 
Aggregation Memo to clarify the inclusion of affiliated entities, not 
only affiliated broker-dealers as in the current version of the 
Aggregation Memo.
    Any member or non-member affiliate relying on the Exemption must 
designate, by prior written notice to the Exchange, each trading unit 
or entity whose options positions are required by Exchange rules to be 
aggregated with the options positions of such member or non-member 
affiliate relying on the Exemption for purposes of compliance with 
Exchange position or exercise limits.\17\
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    \17\ See proposed Commentary .09(d)(3) to Phlx Rule 1001.
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    Obligations of Members and Affiliates. Any member relying on the 
Exemption would be required to provide a written certification to the 
Exchange that it is using a permitted pricing model as defined in the 
rule for purposes of the Exemption. In addition, by such reliance, such 
member would authorize any other person carrying for such member an 
account including, or with whom such member has entered into, a 
position in or relating to a security underlying the relevant option 
position to provide to the Exchange or OCC such information regarding 
such account or position as the Exchange or OCC may request as part of 
the Exchange's confirmation or verification of the accuracy of any net 
delta calculation under this exemption.\18\
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    \18\ See proposed Commentary .09(e) to Phlx Rule 1001.
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    The options positions of a non-member affiliate relying on the 
Exemption must be carried by a member with whom it is affiliated. A 
member carrying an account that includes an equity option position for 
a non-member affiliate that intends to rely on the Exemption would be 
required to obtain from such non-member affiliate a written 
certification that it is using a permitted pricing model as defined in 
the rule for purposes of the Exemption.\19\
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    \19\ In addition, the member would be required to obtain from 
such non-member affiliate a written statement confirming that such 
non-member affiliate: (a) Is relying on the Exemption; (b) will use 
only a permitted pricing model for purposes of calculating the net 
delta of its option positions for purposes of the Exemption; (c) 
will promptly notify the member if it ceases to rely on the 
Exemption; (d) authorizes the member to provide to the Exchange or 
the OCC such information regarding positions of the non-member 
affiliate as the Exchange or OCC may request as part of the 
Exchange's confirmation or verification of the accuracy of any net 
delta calculation under the Exemption; and (e) if the non-member 
affiliate is using the OCC Model, has duly executed and delivered to 
the Exchange such documents as the Exchange may require to be 
executed and delivered to the Exchange as a condition to reliance on 
the Exemption. See proposed Commentary .09(e)(3)(ii) to Phlx Rule 
1001.
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    Reporting. Under proposed Commentary .09(f) to Phlx Rule 1001, each 
member relying on the Exemption would be required to report, in 
accordance with Phlx Rule 1003,\20\ (i) all equity option positions 
(including those that are delta neutral) that are reportable 
thereunder, and (ii) on its own behalf or on behalf of a designated 
aggregation unit pursuant to Commentary .09(d), for each such account 
that holds an equity option position subject to the Exemption in excess 
of the levels specified in Phlx Rule 1001, the net delta and the 
options contract equivalent of the net delta of such position.
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    \20\ Phlx Rule 1003 requires, among other things, that members 
report to the Exchange aggregate long or short positions on the same 
side of the market of 200 or more contracts of any single class of 
options contracts dealt in on the Exchange.
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    The Exchange and other self-regulatory organizations are working on 
modifying the Large Options Position Report (``LOPR'') system and/or 
OCC reports to allow a member to indicate that an equity options 
position is delta neutral.
    Records. Under proposed Commentary .09(g) to Phlx Rule 1001, each 
member relying on the Exemption would be required to (i) retain, and 
would be required to undertake reasonable efforts to ensure that any 
non-member affiliate of the member relying on the exemption retains, a 
list of the options, securities and other instruments underlying each 
options position net delta calculation reported to the Exchange 
hereunder, and (ii) produce such information to the Exchange upon 
request.\21\
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    \21\ A member would be authorized to report position information 
of its non-member affiliate pursuant to the written statement 
required under proposed Commentary .09(e)(3)(ii) to Phlx Rule 1001.
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    Reliance on Federal Oversight. As provided under proposed 
Commentary .09(c) of Phlx Rule 1001, a permitted pricing model includes 
proprietary pricing models used by members and affiliates that have 
been approved by the Commission, the Fed or another federal financial 
regulator. In adopting the proposed Exemption, the Exchange would be 
relying upon the rigorous approval processes and ongoing oversight of a 
federal financial regulator. The Exchange notes that it would not be 
under any obligation to verify whether a member's or its affiliate's 
use of a proprietary pricing model is appropriate or yielding accurate 
results.
    The Exchange will announce the operative date of the proposed rule 
change in a regulatory circular to be published no later than 30 days 
after the Commission issues a release regarding the proposal herein. 
The operative date shall be no later than 15 days after publication of 
the regulatory circular.
2. Statutory Basis
    The Exchange believes the proposed rule change is consistent with 
Section 6(b) of the Act,\22\ in general, and furthers the objectives of 
Section 6(b)(5) of the Act,\23\ in particular, in that it is designed 
to promote just and equitable principles of trade, to prevent 
fraudulent and manipulative acts and practices, 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. The Exchange believes the proposed delta neutral-based hedge 
exemption from equity options position and exercise limits is 
appropriate in that it is based on a widely accepted risk management 
method used in options trading. Also, the Commission has previously 
stated its support for recognizing options positions hedged on a delta 
neutral basis as properly exempted from position limits.\24\
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    \22\ 15 U.S.C. 78f(b).
    \23\ 15 U.S.C. 78f(b)(5).
    \24\ See Securities Exchange Act Release No. 40594 (October 23, 
1998), 63 FR 59362, 59380 (November 3, 1998) (S7-30-97) (adopting 
rules relating to OTC Derivatives Dealers).

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[[Page 11181]]

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 that is not necessary or appropriate 
in furtherance of the purposes of the Act.

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

    Because the foregoing rule change does not: (1) Significantly 
affect the protection of investors or the public interest; (2) impose 
any significant burden on competition; and (3) become operative for 30 
days after the date of this filing, or such shorter time as the 
Commission may designate, it has become effective pursuant to Section 
19(b)(3)(A) of the Act \25\ and Rule 19b-4(f)(6) thereunder.\26\
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    \25\ 15 U.S.C. 78s(b)(3)(A).
    \26\ 17 CFR 240.19b-4(f)(6).
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    A proposed rule change filed under 19b-4(f)(6) normally may not 
become operative prior to 30 days after the date of filing.\27\ 
However, Rule 19b-4(f)(6)(iii) \28\ permits the Commission to designate 
a shorter time if such action is consistent with the protection of 
investors and the public interest. The Exchange has requested that the 
Commission waive the 30-day operative delay. The Commission believes 
that waiving the 30-day operative delay is consistent with the 
protection of investors and the public interest because such waiver 
would allow the Exchange to implement the delta hedging exemption from 
equity options position limits without needless delay. The Commission 
notes that it recently approved a substantially similar proposal filed 
by the Chicago Board Options Exchange, Incorporated.\29\ The Commission 
believes that Phlx's proposal to create a delta hedging exemption from 
equity options position limits raises no new issues. For these reasons, 
the Commission designates the proposed rule change to be operative upon 
filing with the Commission.\30\
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    \27\ 17 CFR 240.19b-4(f)(6)(iii). In addition, Rule 19b-
4(f)(6)(iii) requires that a self-regulatory organization submit to 
the Commission written notice of its intent to file the proposed 
rule change, along with a brief description and text of the proposed 
rule change, at least five business days prior to the date of filing 
of the proposed rule change, or such shorter time as designated by 
the Commission. The Exchange has satisfied the five-day pre-filing 
notice requirement.
    \28\ Id.
    \29\ See Securities Exchange Act Release No. 56970 (December 14, 
2007), 72 FR 72428 (December 20, 2007) (SR-CBOE-2007-99).
    \30\ For the purposes only of waiving the 30-day operative 
delay, the Commission has considered the proposed rule's impact on 
efficiency, competition, and capital formation. See 15 U.S.C. 
78c(f).
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    At any time within 60 days of the filing of such 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.

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 e-mail to rule-comments@sec.gov. Please include 
File Number SR-Phlx-2008-07 on the subject line.

Paper Comments

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

All submissions should refer to File Number SR-Phlx-2008-07. 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 inspection and 
copying 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 the filing also will be available for 
inspection and copying at the principal office of Phlx. 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-2008-07 and should be 
submitted on or before March 21, 2008.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\31\
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    \31\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
 [FR Doc. E8-3843 Filed 2-28-08; 8:45 am]

BILLING CODE 8011-01-P
