
[Federal Register: February 29, 2008 (Volume 73, Number 41)]
[Notices]               
[Page 11173-11177]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr29fe08-129]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-57358; File No. SR-NYSEArca-2008-17]

 
Self-Regulatory Organizations; NYSE Arca, 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 6, 2008, NYSE Arca, Inc. (``NYSE Arca'' or ``Exchange'') 
filed with the Securities and Exchange Commission (``Commission'') the 
proposed rule change as described in Items I and II

[[Page 11174]]

below, which Items have been substantially prepared by NYSE Arca. 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

    NYSE Arca proposes to amend Exchange Rule 6.8 in order to create a 
delta hedging exemption from equity options position limits. The text 
of the proposed rule change is available at NYSE Arca, the Commission's 
Public Reference Room, and http://www.nysearca.com.

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, NYSE Arca 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. NYSE Arca 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
    All options traded on the Exchange are subject to position and 
exercise limits, as provided under NYSE Arca Rule 6.8.\5\ Position 
limits are imposed, generally, to maintain fair and orderly markets for 
options and other securities by limiting the amount of control by one 
or more affiliated persons or entities over one particular options 
class or the security or securities that underlie that options class. 
Exchange rules also contain various hedge exemptions to allow certain 
hedged positions in excess of the applicable standard position 
limit.\6\
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    \5\ Position limits for index options are provided separately 
under NYSE Arca Rule 5.15 through Rule 5.17.
    \6\ See NYSE Arca Rule 6.8 Commentary .07-.08.
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    Over the years, NYSE Arca has, at times, 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 (i.e., 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. 55347 (February 26, 
2007), 72 FR 9823 (March 5, 2007) (SR-NYSEArca-2007-19); 54385 
(August 30, 2006), 71 FR 53150 (September 8, 2006) (SR-NYSEArca-
2006-49); 51286 (March 1, 2005) 70 FR 11297 (SR-PCX-2003-55); and 
45737 (April 11, 2005), 67 FR 18975 (SR-PCX-2000-45).
    \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 NYSE Arca OTP Holders and OTP 
Firms,\10\ and certain of their affiliates, that are ``delta neutral'' 
\11\ 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'')).\12\
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    \9\ NYSE Arca Rule 6.9 establishes exercise limits for an option 
at the same level as the option's position limit under NYSE Arca 
Rule 6.8; therefore, no changes are proposed to Rule 6.9.
    \10\ OTP Holders (NYSE Arca Rule 1.1(q)) and OTP Firms (NYSE 
Arca Rule 1.1(r)) have the status of a ``member'' of the Exchange as 
defined in Section 3 of the Act, 15 U.S.C. 78c.
    \11\ The term ``delta neutral'' is defined in proposed Rule 6.8 
Commentary .09(a) 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.
    \12\ The Exchange intends to submit a separate proposed rule 
change 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.\13\
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    \13\ Under proposed Rule 6.8 Commentary .09(b) 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 Rule 6.8 Commentary .09(c) to mean the pricing 
model maintained and operated by The Options Clearing Corporation 
(``OCC'') and the pricing models used by: (i) An OTP Holder or OTP Firm 
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; \14\

[[Page 11175]]

(iii) a Commission-registered OTC derivatives dealer; \15\ and (iv) a 
national bank.\16\
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    \14\ 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 (``FRB''), 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 FRB, provided that the OTP Holder or OTP Firm (or affiliate 
thereof) 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 OTP 
Holder or OTP Firm (or affiliate thereof) 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 
subsection (c)(3) of proposed Rule 6.8 Commentary .09.
    \15\ The pricing model of a Commission-registered OTC 
derivatives dealer would have to be consistent with the requirements 
of Appendix F to Rules 15c3-1 and 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 an OTP 
Holder or OTP Firm) would be able to rely on this part of the 
Exemption. See subsection (c)(4) of proposed Rule 6.8 Commentary 
.09.
    \16\ 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 an OTP Holder or OTP Firm) would be able to rely on this 
part of the Exemption. See subparagraph (c)(5) of proposed Rule 6.8 
Commentary .09.
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    Aggregation of Accounts. An OTP Holder or OTP Firm (or an affiliate 
thereof) 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 OTP Holder or OTP Firm, or its affiliate.
    However, the net delta of an options position held by an entity 
entitled to rely on the Exemption, or by a separate 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 \17\ 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.\18\
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    \17\ For purposes of the proposed rule, ``control'' is as 
defined in Position and Exercise Limits, NYSE Arca Regulatory 
Bulletin RBO-07-08 (August 31, 2007).
    \18\ See subsection (d) of proposed Rule 6.8 Commentary .09.
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    The Exchange has previously set forth in a regulatory bulletin the 
conditions under which it will deem control exists between affiliated 
broker dealers and between separate and distinct trading units within 
the same broker-dealer.\19\ The Exchange will also issue a subsequent 
regulatory bulletin, explaining the aggregation of accounts, for the 
purpose of position limits, for broker-dealers and their non-broker 
dealer affiliates. The Exchange will issue this bulletin prior to the 
operative date of this rule change.
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    \19\ See supra note 17.
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    Any OTP Holder or OTP Firm (or affiliate thereof) 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 OTP Holder or 
OTP Firm (or affiliate thereof) relying on the Exemption for purposes 
of compliance with Exchange position or exercise limits.\20\
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    \20\ See subparagraph (d)(3) of proposed Rule 6.8 Commentary 
.09.
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    Obligations of OTP Holders and OTP Firms (and affiliates thereof). 
Any OTP Holder or OTP Firm 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 OTP Holder or OTP Firm 
would authorize any other person carrying for such OTP Holder or OTP 
Firm an account including, or with whom such OTP Holder or OTP Firm 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.\21\
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    \21\ See subsection (e) of proposed Rule 6.8 Commentary .09.
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    The options positions of a non-OTP Holder or Firm affiliate, 
relying on the Exemption must be carried by an OTP Holder or OTP Firm 
with which it is affiliated. An OTP Holder or OTP Firm carrying an 
account that includes an equity option position for an affiliate that 
intends to rely on the Exemption would be required to obtain from such 
affiliate a written certification that it is using a permitted pricing 
model as defined in the rule for purposes of the Exemption.\22\
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    \22\ In addition, the OTP Holder or OTP Firm would be required 
to obtain from such affiliate a written statement confirming that 
such 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 affiliated OTP Holder or OTP Firm if it ceases 
to rely on the Exemption; (d) authorizes the OTP Holder or OTP Firm 
to provide to the Exchange or the OCC such information regarding 
positions of the 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 
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 subparagraph (e)(3) of proposed Rule 6.8 
Commentary .09.
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    Reporting. Under proposed Rule 6.8 Commentary .09(f) each OTP 
Holder or OTP Firm relying on the Exemption would be required to 
report, in accordance with Rule 6.6,\23\ (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 proposed Rule 6.8 Commentary .09(d), for 
each such account that holds an equity option position subject to the 
Exemption in excess of the levels specified in Rule 6.8(a) Commentary 
.05-06, the net delta and the options contract equivalent of the net 
delta of such position.
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    \23\ NYSE Arca Rule 6.6 requires, among other things, that OTP 
Holders and OTP Firms 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 system and/or OCC reports 
to allow a member organization to indicate that an equity options 
position is delta neutral.
    Records. Under proposed Rule 6.8 Commentary .09(g) each OTP Holder 
or OTP Firm relying on the Exemption would be required to (i) retain, 
and would be required to undertake reasonable efforts to ensure that 
any affiliate of the OTP Holder or OTP Firm 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.\24\
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    \24\ An OTP Holder or OTP Firm would be authorized to report 
position information of its affiliate pursuant to the written 
statement required under proposed Rule 6.8 Commentary 
.09(e)(3)(ii)(d).
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    Reliance on Federal Oversight. As provided under proposed Rule 6.8 
Commentary .09(c) a permitted pricing model includes proprietary 
pricing models used by OTP Holders and OTP Firms (and affiliates 
thereof) that have been approved by the Commission, the FRB, or another 
federal financial regulator. In adopting the proposed Exemption, the 
Exchange would be

[[Page 11176]]

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 an OTP Holder or OTP Firm or its 
affiliate's use of a proprietary pricing model is appropriate or 
yielding accurate results.
    This rule change will become effective upon filing, although it 
will not become operative until such time that the Exchange, the OCC, 
and the Securities Industry Automation Corporation (``SIAC'') have 
completed required technology changes to automated reports used for 
position limit surveillance. The operative date for the rule change 
will be announced by NYSE Arca via an options regulatory bulletin, 
within 30 days following the effective date of the filing. OTP Firms 
and OTP Holders will not be able to take advantage of the delta 
neutral-based equity hedge exemption contained in this proposal until 
the announced operative date.
2. Statutory Basis
    The Exchange believes the proposed rule change is consistent with 
Section 6(b) of the Act,\25\ in general, and furthers the objectives of 
Section 6(b)(5) of the Act,\26\ 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.\27\
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    \25\ 15 U.S.C. 78f(b).
    \26\ 15 U.S.C. 78f(b)(5).
    \27\ 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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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

    Written comments on the proposed rule change were neither solicited 
nor 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 \28\ and Rule 19b-4(f)(6) thereunder.\29\
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    \28\ 15 U.S.C. 78s(b)(3)(A).
    \29\ 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.\30\ 
However, Rule 19b-4(f)(6)(iii) \31\ 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.\32\ The Commission 
believes that NYSE Arca'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.\33\
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    \30\ 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.
    \31\ Id.
    \32\ See Securities Exchange Act Release No. 56970 (December 14, 
2007), 72 FR 72428 (December 20, 2007) (SR-CBOE-2007-99).
    \33\ 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-NYSEArca-2008-17 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-NYSEArca-2008-17. 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 NYSE Arca. 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

[[Page 11177]]

submissions should refer to File Number SR-NYSEArca-2008-17 and should 
be submitted on or before March 21, 2008.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\34\
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    \34\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. E8-3844 Filed 2-28-08; 8:45 am]

BILLING CODE 8011-01-P
