
[Federal Register: September 28, 2009 (Volume 74, Number 186)]
[Notices]               
[Page 49419-49425]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr28se09-112]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-60711; File No. SR-NYSEArca-2009-44]

 
Self-Regulatory Organizations; NYSE Arca, Inc.; Notice of Filing 
of Amendment Nos. 1 and 3 and Order Granting Partial Accelerated 
Approval of a Proposed Rule Change, as Modified by Amendment Nos. 1 and 
3 Thereto, Amending NYSE Arca Rule 6.72 and Expanding the Penny Pilot 
Program

September 23, 2009.

I. Introduction

    On May 15, 2009, 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 its options trading rule to extend through December 31, 2010 and 
expand a program to quote certain options in smaller increments 
(``Pilot Program'' or ``Pilot'').\3\ The proposed rule change was 
published for comment in the Federal Register on May 27, 2009.\4\ The 
Commission received nine comment letters in response to the proposed 
rule change.\5\ On August 18, 2009, the Exchange responded to the 
comment letters \6\ and filed Amendment

[[Page 49420]]

No. 1 to the proposed rule change.\7\ On September 21, 2009, the 
Exchange filed Amendment No. 2 to the proposed rule change. On 
September 22, 2009, the Exchange withdrew Amendment No. 2 and filed 
Amendment No. 3. Among other things, in Amendment No. 3 the Exchange 
consented to a bifurcation of the filing such that the portion of the 
proposed rule change proposing to quote IWM and SPY entirely in pennies 
would be subject to further notice and comment prior to Commission 
action.\8\ The Commission is publishing this notice to solicit comments 
on the proposed rule change, as modified by Amendment Nos. 1 and 3, and 
simultaneously is partially approving the proposed rule change, as 
modified by Amendment Nos. 1 and 3, on an accelerated basis.\9\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ The current pilot is scheduled to expire on October 31, 
2009. See Securities Exchange Act Release No. 60224 (July 1, 2009), 
74 FR 32991 (July 9, 2009).
    \4\ See Securities Exchange Act Release No. 59944 (May 20, 
2009), 74 FR 25294 (May 27, 2009) (``Notice'').
    \5\ See letter from Stephen Schuler and Daniel Tierney, Managing 
Members, Global Electronic Trading Company, dated June 10, 2009 
(``GETCO Letter''); letter from Edward J. Joyce, President and COO, 
Chicago Board Options Exchange, dated June 12, 2009 (``CBOE 
Letter''); letter from Thomas Wittman, Vice President, The NASDAQ 
OMX Group, Inc., dated June 12, 2009 (``Nasdaq Letter''); letter 
from Christopher Nagy, Managing Director Order Routing Strategy, TD 
Ameritrade, Inc., dated June 17, 2009 (``Ameritrade Letter''); 
letter from Thomas F. Price, Managing Director, Securities Industry 
and Financial Markets Association, dated June 17, 2009 (``SIFMA 
Letter''); letter from Anthony J. Saliba, CEO, LiquidPoint LLC, 
dated June 17, 2009 (LiquidPoint Letter''); letter from Michael J. 
Simon, Secretary, International Securities Exchange, LLC, dated June 
23, 2009 (``ISE Letter''); letter from John Ingrill, Gerard Satur, 
Karen Wendell, Managing Directors, UBS Securities LLC, dated June 
30, 2009 (``UBS Letter''); and letter from Jerome Johnson, Vice 
President, Market Development, BATS Exchange, Inc., dated August 28, 
2009 (``BATS Letter'') (collectively, the ``Comment Letters'').
    \6\ See letter from Janet M. Kissane, Senior Vice President--
Legal & Corporate Secretary, NYSE Arca, to Elizabeth M. Murphy, 
Secretary, Commission, dated August 18, 2009 (``NYSE Arca 
Response'').
    \7\ In Amendment No. 1, the Exchange: (i) Clarified how 
replacement issues would be selected in the event that a Pilot class 
were delisted; (ii) proposed to begin the phased implementation of 
the expansion of the Pilot on September 28, 2009 and continue over 
four successive quarters; and (iii) clarified that under its 
proposal NYSE Arca would begin quoting SPY and IWM entirely in 
pennies on September 28, 2009. See infra note 17 with respect to 
that portion of the proposal to change the quoting increments for 
options on SPY and IWM.
    \8\ Also, in Amendment No. 3, the Exchange clarified the 
threshold levels for determining when an options class would not be 
eligible to participate in the Pilot due to a high premium. The 
Exchange also proposed to begin the phased implementation of the 
Pilot on October 26, 2009 and continue over four successive 
quarters. The Exchange has consented to an extension of time for the 
Commission to act until October 31, 2009.
    \9\ See infra note 17 and accompanying text.
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II. Description of the Proposal

    Currently, all seven options exchanges participate in the Pilot 
Program, which is scheduled to expire on October 31, 2009.\10\ The 
Exchange proposes to extend the time period of the Pilot Program 
through December 31, 2010 and expand the Pilot Program.
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    \10\ See Securities Exchange Act Release Nos. 55156 (January 23, 
2007), 72 FR 4759 (February 21, 2007); 56568 (September 27, 2007), 
72 FR 56422 (October 3, 2007); 59628 (March 26, 2009), 74 FR 15025 
(April 2, 2009); and 60224 (July 1, 2009) 74 FR 32991 (July 9, 
2009).
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    NYSE Arca proposes to add the next 300 most actively traded, 
multiply listed options classes that are not currently included in the 
Pilot Program, excluding options with high premiums.\11\ The Exchange 
proposes to phase-in these 300 classes in groups of 75 additional 
classes each quarter over four successive quarters on October 26, 2009, 
January 25, 2009, April 26, 2010 and July 26, 2010.\12\ The Exchange 
will identify the classes to be added each quarter based on national 
average daily volume in the prior six calendar months immediately 
preceding their addition to the Pilot Program, using data compiled and 
disseminated by the Options Clearing Corporation. The Exchange will 
announce the classes to be added to the Pilot Program each quarter to 
the Exchange's membership in a Regulatory Bulletin and by publishing 
the information on its Web site, in addition to submitting a filing 
with the Commission.\13\
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    \11\ One commenter raised issues with the aspect of NYSE Arca's 
proposal that would exclude options with high premiums, claiming 
that the Exchange's proposal did not give guidance, definition or 
indication of what constitutes a ``high premium.'' See CBOE Letter, 
supra note 5, at 2. In response to this comment, NYSE Arca clarified 
in Amendment No. 3 that a class would be excluded from the Pilot for 
having a high premium if at the time of selection of new classes the 
underlying equity security was priced at $200 per share or above or 
the underlying index level was at 200 or above. The determination of 
whether a security is trading above $200 or above a calculated index 
value of 200 shall be based on the price at the close of trading on 
the Expiration Friday prior to being added to the Pilot. See supra 
note 8, and NYSE Arca Response, supra note 6, at 3-4.
    \12\ See supra note 8.
    \13\ The Exchange has committed to file a proposed rule change 
under Section 19(b)(3)(A) of the Act to identify the option classes 
to be included each quarter.
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    The minimum variation for all classes to be included in the Pilot, 
except for QQQQ, will continue to be $0.01 for all quotations in option 
series that are quoted at less than $3.00 per contract, and $0.05 for 
all quotations in option series that are quoted at $3.00 or greater. 
Options on QQQQ will continue to be quoted in $0.01 increments for all 
series. Further, the Exchange proposes to designate options on SPY 
(SPDR S&P 500 ETF) and IWM (iShares Russell 2000 Index Fund) as 
eligible to quote and trade all options series in one cent increments, 
regardless of premium value.\14\
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    \14\ See supra note 8 and infra note 17.
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    The Exchange further proposes that any option class included in the 
Pilot Program that has been delisted may be replaced on a semi-annual 
basis by the next most actively traded, multiply listed options class 
that is not yet included in the Pilot, based on trading activity in the 
previous six months.\15\ The replacements issue(s) would be added to 
the Pilot Program on the second trading day following January 1, 2010 
and July 1, 2010.\16\
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    \15\ In Amendment No. 1, the Exchange clarified that the 
replacement classes also would exclude options with high premiums. 
See supra note 7.
    \16\ The replacement issues will be announced to the Exchange's 
membership in a Regulatory Bulletin and published by the Exchange on 
its Web site.
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    The Exchange will submit semi-annual reports to the Commission that 
will include sample data and analysis of information collected from 
April 1 through September 30, and from October 1 through March 31, for 
each year, for the ten most active and twenty least active options 
classes added to the Pilot Program, in addition to continuing to 
provide data concerning the existing Pilot Program classes. The 
Exchange also will identify, for comparison purposes, a control group 
consisting of the ten least active options classes from the existing 
Pilot Program classes. The report will include, but not be limited to 
the following: (1) Data and analysis on the number of quotations 
generated for options included in the report; (2) an assessment of the 
quotation spreads for the options included in the report; (3) an 
assessment of the impact of the Pilot Program on the capacity of NYSE 
Arca's automated systems; (4) data reflecting the size and depth of 
markets; and (5) any capacity problems or other problems that arose 
related to the operation of the Pilot Program and how the Exchange 
addressed them.

III. Discussion and Findings

    After careful review of the proposed rule change, Amendment Nos. 1 
and 3, the Comment Letters, and the NYSE Arca Response, the Commission 
finds that the proposed rule change, as amended, except for the portion 
of the proposal to quote IWM and SPY entirely in pennies, is consistent 
with the requirements of the Act, and the rules and regulations 
thereunder that are applicable to a national securities exchange.\17\ 
Specifically, the Commission finds that the proposal is consistent with 
Section 6(b)(5) of the Act,\18\ which requires, among other things, 
that the rules of a national securities 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.\19\
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    \17\ The Commission is not at this time approving the portion of 
the proposed rule change that would designate options on IWM and SPY 
as eligible to quote all options series in one-cent increments. The 
Commission is soliciting further comment on that portion of the 
proposed rule change. See infra Section IV.
    \18\ 15 U.S.C. 78f(b)(5).
    \19\ In approving the 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).
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    On June 28, 2005, the Pacific Exchange (now known as NYSE Arca) 
announced its intention to begin quoting and trading all listed options 
in penny increments.\20\ In June 2006, to

[[Page 49421]]

facilitate the orderly transition to quoting a limited number of 
options in penny increments, the then Chairman of the Commission sent a 
letter to the six options exchanges urging the exchanges that chose to 
begin quoting in smaller increments to plan for the implementation of a 
limited penny pilot program to commence in January 2007.\21\ The then 
existing options exchanges submitted proposals to permit quoting a 
limited number of classes in smaller increments, and, in January 2007, 
the Commission approved those proposals to implement the current Pilot 
Program.\22\ The Pilot, which has since been extended and expanded, 
currently includes 63 classes and is scheduled to expire on October 31, 
2009.\23\ NYSE Arca now proposes to extend and further expand the 
Pilot.
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    \20\ PCX News Release, ``Pacific Exchange to Trade Options in 
Pennies,'' June 28, 2005.
    \21\ Commission Press Release 2006-91, ``SEC Chairman Cox Urges 
Options Exchanges to Start Limited Penny Quoting,'' June 7, 2006.
    \22\ See Securities Exchange Act Release Nos. 55154 (January 23, 
2007), 72 FR 4743 (February 1, 2007) (SR-CBOE-2006-92); 55162 
(January 24, 2007), 72 FR 4738 (February 1, 2007) (Amex-2006-106); 
55155 (January 23, 2007), 72 FR 4741 (February 1, 2007) (SR-BSE-
2006-49); 55161 (January 24, 2007), 72 FR 4754 (February 1, 2007) 
(SR-ISE-2006-62); 55156 (January 23, 2007), 72 FR 4759 (February 1, 
2007) (SR-NYSEArca-2006-73); and 55153 (January 23, 2007), 72 FR 
4553 (January 31, 2007) (SR-Phlx-2006-74).
    \23\ See supra note 3. Although the proposed rule changes 
approved by the Commission to implement and expand the Pilot provide 
for 65 classes in the current Pilot Program, the actual number of 
those classes still trading is 59.
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    The Commission believes that NYSE Arca's proposal is consistent 
with the Act in large measure because allowing market participants to 
quote in smaller increments has been shown to reduce spreads, thereby 
lowering costs to investors. An analysis of the current Pilot shows 
that the reduction in the minimum quoting increment has resulted in 
narrowing the average quoted spreads in classes included in the 
Pilot.\24\ The reduction in spreads also has led the exchanges to 
reduce or eliminate their exchange-sponsored payment-for-order-flow 
programs.\25\ The Commission believes that the proposed rule change, 
which will expand the Pilot to include 300 of the next most actively 
traded, multiply listed classes, is designed to allow the continuing 
narrowing of spreads.
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    \24\ See Memorandum to Heather Seidel, from J. Daniel Aromi, 
Office of Economic Analysis (``OEA''), ``Volume and Spreads for 
Pilot and Non-Pilot Options Classes,'' dated July 24, 2009 (``OEA 
Memo''). See also Ameritrade Letter, supra note 5, at 1 (noting the 
firm's belief that overall, the Pilot has brought about tighter 
trading increments); GETCO Letter, supra note 5, at 1 (noting as a 
benefit of the Pilot the substantial decreases in quoted spreads); 
UBS Letter, supra note 5, at 1 (noting that spreads have narrowed as 
a result of penny quoting); and BATS Letter, supra note 5, at 1-2 
(noting a reduction in spreads in Pilot classes).
     Average spread width reductions for some options included in 
the Pilot were less during the period from approximately August 2008 
through January 2009 than in prior periods. See e.g., CBOE Penny 
Pilot Report, dated March 9, 2009 (``CBOE March Report'') at 2; CBOE 
Penny Pilot Report, dated September 4, 2008 (``CBOE September 
Report'') at 1 to 5; and Report by BOX, BOX Penny Pilot Report: 
Penny Pilot Report 5 (``BOX Penny Pilot Report 5'') at 7. However, 
this time frame covers a period of significant overall market 
volatility. The CBOE Volatility Index (``VIX'') was well above 
previous levels through most of this period. From late September 
2008 through January 2009 (and beyond) the VIX was almost always 
above 40, peaking at 80 in October and November 2008. See also 
Report by NYSE Arca, The Options Penny Pilot, dated August 18, 2009 
(``NYSE Arca Report'') at 7 to 10 and Report by NYSE Arca, Reporting 
Period 5 (``NYSE Arca Report 2'') (showing overall greater 
reductions in volume-weighted average spreads for the period 
February 1, 2009 through April 30, 2009 as compared to the period 
August 1, 2008 through January 31, 2009); CBOE March Report at 2 and 
CBOE Penny Pilot Report, dated July 31, 2009 (``CBOE July Report'') 
at 2 (these reports show that the average spread width decreased 
from the period of February 1, 2009 through April 30, 2009, as 
compared to the period of August 1, 2008 through January 1, 2009); 
and Report by BOX, BOX Penny Pilot Report: Penny Pilot Report 6 
(``BOX Penny Pilot Report 6'') at 7 (stating that the average bid/
ask spread narrowed in the period February 1, 2009 through April 30, 
2009 as compared to the period from August 1, 2008 though January 
31, 2009). Further, one exchange that measured average spreads in 
non-Pilot classes during the same time period for which it measured 
average spreads for Pilot classes showed that average spreads in 
non-Pilot classes also widened. See Report by ISE, Penny Pilot 
Analysis 5, dated May 2009 (``ISE Report'') at 4. ISE provides 
statistics showing volume-weighted spreads for the classes in each 
phase of the Pilot, for the 3 months prior to each group being 
included in the Pilot, the first year after inclusion in the Pilot, 
and the six months from November 2008 to April 2009, as well as 
volume-weighted spread statistics for comparable classes not 
included in the Pilot for the same time periods as used for the 
classes in phase 3 of the Pilot. The data shows that the spreads for 
the non-penny classes also widened in the time period from November 
2008 to April 2009. See also CBOE March Report at 2 (stating that 
the exchange is aware that average spread width in many non-Pilot 
classes widened during the same reporting period due to the unusual 
market conditions that existed).
    \25\ See Securities Exchange Act Release Nos. 55328 (February 
21, 2007), 72 FR 9050 (February 28, 2007) (SR-Amex-2007-16); 55197 
(January 30, 2007), 72 FR 5772 (February 7, 2007) (SR-BSE-2007-02); 
55265 (February 9, 2007), 72 FR 7697 (February 16, 2007) (SR-CBOE-
2007-11); 55271 (February 12, 2007), 72 FR 7699 (February 16, 2007) 
(SR-ISE-2007-08); 55223 (February 1, 2007) 72 FR 6306 (February 9, 
2007) (SR-NYSEArca-2007-07); and 55290 (February 13, 2007), 72 FR 
8051 (February 22, 2007) (SR-Phlx-2007-05).
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    One commenter stated that ``full access to penny increments 
provides investors with more flexibility to compete and determine the 
natural spread for each security independently.'' This commenter 
further stated that ``penny pricing gives market participants the 
flexibility to trade with spreads at six or eleven cents wide, as much 
as it facilitates trading in one or two cent spreads.'' \26\ This 
commenter explained that even if spreads in a Pilot class increase, 
quoting in pennies mitigates the increase. For example, the commenter 
noted that CBOE's March Report showed that for the period August 1, 
2008 through January 31, 2009, the average spread in OIH options 
increased from $0.13 to $0.19. The commenter pointed out that if this 
class were not quoting in pennies, the $0.06 increase in the spread 
could have been a $0.10 increase.
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    \26\ See BATS Letter, supra note 5, at 1-2.
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    Several commenters expressed concern about the impact of NYSE 
Arca's proposal on displayed size that will be available at the best 
bid and offer in the additional classes to be included in the Pilot, 
and the impact that a decrease in displayed size would have on the 
market quality.\27\ In particular, several commenters expressed concern 
that decreased liquidity in Pilot classes has made, and will continue 
to make, it harder for market participants to execute orders of large 
size.\28\ They argue that decreased liquidity in Pilot classes is 
causing market participants to seek liquidity from off-exchange venues, 
such as the OTC market or off-exchange dark pools, which results in 
less transparent markets.\29\ Several commenters also expressed 
concerns with the potential impact of increased quotation traffic on 
costs to exchanges and other market participants to process and store 
the additional quotations, and on the ability of market systems to 
effectively handle increased quotation traffic if NYSE Arca's proposal 
were approved.\30\
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    \27\ See, e.g., CBOE Letter, supra note 5, at 2; LiquidPoint 
Letter, supra note 5, at 4; SIFMA Letter, supra note 5, at 4-5; and 
UBS Letter, supra note 5, at 1.
    \28\ See, e.g., SIFMA Letter, supra note 5, at 4; and UBS 
Letter, supra note 5, at 1.
    \29\ See ISE Letter, supra note 5, at 3-4; and SIFMA Letter, 
supra note 5, at 4.
    \30\ See, e.g., CBOE Letter, supra note 5, at 2; ISE Letter, 
supra note 5, at 5; and SIFMA Letter, supra note 5, at 4.
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    These commenters generally believe that to mitigate any concerns 
about the impact of decreased displayed size and increased quotation 
traffic from the Pilot, classes included in the Pilot Program should 
have a $1, rather than $3, breakpoint.\31\ These commenters generally 
believe that a $1 breakpoint would appropriately balance the benefits 
of narrower spreads for an expanded number of options against the 
strain on systems capacity and increased costs due to increased 
quotation traffic and reduced liquidity at the national best bid and 
offer, by concentrating the benefits where

[[Page 49422]]

customers trade the most and provide the most liquidity.\32\
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    \31\ See, e.g., CBOE Letter, supra note 5, at 4; LiquidPoint 
Letter, supra note 5, at 3-4; SIFMA Letter, supra note 5, at 2-3; 
and UBS Letter, supra note 5, at 1.
    \32\ See, e.g., LiquidPoint Letter, supra note 5, at 4; SIFMA 
Letter, supra note 5, at 1-2; and UBS Letter, supra note 5, at 1-2.
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    The Commission continues to believe that the impact of the Pilot on 
displayed size, as well as on non-displayed depth-of-book, and the 
impact of decreased size on market and execution quality, is an area 
that requires careful analysis as the Pilot continues. The Commission 
further recognizes that the options exchanges have consistently shown 
in their reports that there has been a reduction in the displayed size 
available in the Pilot classes. However, the Commission does not 
believe that the decrease in displayed size that accompanies smaller 
increments and narrower spreads means that NYSE Arca's proposal to 
expand the Pilot is not consistent with the Act. A decrease in 
displayed size available at the best bid or offer may have a greater 
effect on the ability of market participants to execute large-sized 
orders as compared to smaller-sized orders, given the smaller size that 
would be available at that best price. The Commission does not believe 
that the data to date shows that retail customers have been adversely 
affected by the reduction in size at the inside price.\33\
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    \33\ See, e.g., BOX Penny Pilot Report 6, supra note 24, at 6 
(stating that the quantity at the top of the BOX book was sufficient 
to satisfy the average trade size in the Pilot classes); CBOE July 
Report, supra note 24, at 2, 4 and 6 (showing the change in quoted 
size in Pilot classes); ISE Report, supra note 24, at 5 (showing the 
change in volume weighted size at the ISE's best bid or best offer 
in Pilot classes); Nasdaq OMX Phlx, Options Penny Pilot Expansion 
Report 4, dated February 27, 2009, at 3 and 6 (showing the change in 
quoted size at the NBBO in Pilot Classes); NYSE Arca Report, supra 
note 24, at 3-5 (showing that 100 percent of customer and firm 
orders up to 100 contracts in the Pilot classes were filled during 
the periods February 1, 2008 through July 31, 2008 and February 1, 
2009 through April 30, 2009); and NYSE Arca Report, supra note 24, 
at 3 (showing that 100% of customer orders up to 50 contracts in the 
Pilot classes were filled during the period August 1, 2008 to 
January 31, 2009, and 94% of all customer orders in the Pilot 
classes were filled during the same period).
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    Moreover, the Commission anticipates that market participants with 
large sized orders will adjust their trading strategies to accommodate 
smaller displayed size in additional classes quoting in pennies.\34\ 
Importantly, the Commission notes that the new Options Order Protection 
and Locked/Crossed Market Plan (``Linkage Plan'') provides for the use 
of intermarket sweep orders (``ISOs''), which will allow market 
participants to more efficiently access liquidity at multiple price 
levels across exchanges.\35\ Several commenters acknowledged the 
anticipated benefits of the new Linkage Plan, especially for options 
quoted in pennies, and requested that any expansion of the Pilot 
Program be contingent on the implementation of the new options linkage 
plan.\36\ In response to these comments, NYSE Arca amended its proposed 
rule change to modify the phased roll-out of the additional 300 classes 
to begin following implementation of the Linkage Plan on August 31, 
2009.\37\ The Commission agrees with commenters that the ability of 
market participants to use ISOs to access liquidity across exchanges 
and at different price levels will help to address concerns that a 
decrease in displayed size at the BBO negatively impacts the ability to 
execute large sized orders.\38\
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    \34\ See NYSE Arca Response, supra note 6, at 5 (stating that 
the current mechanisms for sourcing block-sized liquidity will 
continue to grow and evolve to meet the demands of users).
    \35\ See Securities Exchange Act Release No. 60405 (July 30, 
2009), 74 FR 39362 (August 6, 2009) (File No. 4-546) (order 
approving Linkage Plan). The Linkage Plan was implemented on August 
31, 2009.
    The Commission encourages the options exchanges to consider 
measures that would facilitate access to depth of book quotations. 
The Commission notes that currently several exchanges make available 
quotations and orders on their respective books below their best bid 
and offer. The Commission anticipates that to the extent display of 
this information proves to be valuable to the options market as a 
whole, other exchanges may choose to make this information available 
as well.
    \36\ See CBOE Letter, supra note 5, at 3; and UBS Letter, supra 
note 5, at 2.
    \37\ See supra note 7. In Amendment No. 3, the Exchange proposed 
to begin the phased implementation on October 26, 2009. See supra 
note 8.
    \38\ Several commenters noted that the introduction of ISOs and 
improvements in order routing technology anticipated as part of the 
new linkage plan would provide an improved trading environment for 
the expansion of penny quoting and permit market participants to 
simultaneously access better priced quotations across all options 
exchanges. See GETCO Letter, supra note 5, at 4 and UBS Letter, 
supra note 5, at 2. See also NYSE Arca Response, supra note 6, at 5 
(stating that the soon-to-be implemented ISO will allow block-sized 
liquidity to be sourced at prices inferior to the NBBO and let it 
trade, offering institutional investors the certainty of both trade 
and price that they need and desire).
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    In addition, one commenter notes a decrease in average daily volume 
in the Pilot classes as a negative effect of the Pilot.\39\ The 
Commission believes that the impact of smaller increments on trading 
volume is one of the more difficult aspects of the Pilot to assess. The 
bid-ask spread is only one factor that influences volume. Other factors 
that impact options volume are trading activity in the underlying 
security and in related products, volatility in the market and in the 
underlying security, as well as firm and market specific events. The 
Commission does not believe that exchange reports show a clear change 
in trading volume, and the Commission's Office of Economic Analysis 
looked at the change in average contract volume for classes included in 
the Pilot and a sample of classes not included in the Pilot, over two 
time periods, finding that volume increased for the Pilot classes as 
compared to the control group of non-Pilot classes (the difference for 
one time period was statistically significant).\40\ Thus, based on the 
data viewed to date, the Commission cannot conclude that the Pilot has 
had an adverse impact on volume in the Pilot securities.
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    \39\ See SIFMA Letter, supra note 5, at 4 (citing to CBOE March 
Report, supra note 24).
    \40\ Memorandum from J. Daniel Aromi, OEA, to Heather Seidel, 
Assistant Director, Division of Trading and Markets, Commission, 
dated August 14, 2009 (``OEA Memo 2'') (looking at the change in 
volume from August to September 2007 to April to May 2008, and from 
August to September 2007 to May to June 2009).
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    As anticipated, the Pilot has contributed to the increase in 
quotation message traffic from the options markets. However, while the 
increase in quotation message traffic is appreciable, it has been 
manageable by the exchanges and the Options Price Reporting Authority 
(``OPRA''), and the Commission did not receive any reports of 
disruptions in the dissemination of pricing information as a result of 
quotation capacity restraints.\41\ While the Commission anticipates 
that NYSE Arca's proposed expansion of the Pilot Program will 
contribute to further increases in quotation message traffic, the 
Commission believes that NYSE Arca's proposal is sufficiently limited 
such that it is unlikely to increase quotation message traffic beyond 
the capacity of market participants' systems and disrupt the timely 
receipt of quote information. NYSE Arca has proposed to roll out the 
additional 300 classes over time, in groups of 75 classes each quarter 
beginning on October 26, 2009. The Commission further notes that a June 
2, 2009 sustained message traffic peak of 852,350 messages per second 
reported by OPRA\42\ is still well below

[[Page 49423]]

OPRA's current messages per second capacity limit of 2,050,000.\43\ 
Moreover, NYSE Arca has adopted and will continue to utilize quote 
mitigation strategies that should continue to mitigate the expected 
increase in quotation traffic.\44\
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    \41\ One commenter states that although the exchange reports 
have shown that quotation traffic has increased significantly, the 
quotation volume has not resulted in significant problems for 
exchanges or market participants. See UBS Letter, supra note 5, at 
1. Another commenter noted that the risks associated with OPRA's 
capacity being overwhelmed appear to be mitigated. See GETCO Letter, 
supra note 5, at 3. Another commenter notes that market participants 
will continue to make the investment in technology that results in 
more efficient markets and states that many of the exchanges have 
doubled the number of physical network connections between 
themselves and OPRA as a result. See BATS Letter, supra note 5, at 
2.
    \42\ See NYSE Arca Report, supra note 24, at 11 (noting a 
sustained five second peak of 852,350 messages per second as 
reported by OPRA on June 2, 2009, and noting OPRA's current output 
capacity of 2,050,000 messages per second, which is scheduled to 
increase to over 3,000,000 messages per second in January 2010).
    \43\ See NYSE Arca Response, supra note 6, at 6 (stating that 
``there has been no outcry from vendors or firms in response to 
quote traffic projections through mid-year 2011, as published by 
[OPRA]'').
    \44\ See Securities Exchange Act Release No. 56157 (July 27, 
2007), 72 FR 42459 (August 2, 2007) (SR-NYSEArca-2007-71) (notice 
and immediate effectiveness of a proposed rule change to implement 
the Exchange's quote mitigation strategy); and NYSE Arca Response, 
supra note 6, at 6 (representing that the Exchange will retain and 
continue to employ its quotation mitigation strategy).
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    As noted above, NYSE Arca has proposed to expand the current Pilot 
Program to the 300 next most actively traded, multiply listed options 
classes, and to continue the existing $3 breakpoint for classes 
included in the Pilot (with the exception of options on QQQQ, IWM, and 
SPY).\45\ The Commission believes that NYSE Arca's proposal is 
consistent with the Act. The Commission believes that the proposed rule 
change is designed to continue the narrowing of spreads in options 
included in the Pilot. NYSE Arca's proposal will provide the 
opportunity for reduced spreads where a significant amount of trading 
occurs, thus maximizing the economic benefits of the Pilot while 
minimizing the impact of increased quotation traffic.\46\ Further, the 
Commission believes that the proposal will provide an opportunity for 
increased transparency in the options markets, by allowing market 
participants to display their trading interest in one-cent increments 
in the consolidated quotation stream.
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    \45\ One commenter argues that NYSE Arca's proposal is confusing 
to investors because it will provide for 355 classes to be quoted in 
pennies and nickels, three classes to be quoted in all pennies, and 
the rest of the classes to be quoted in nickels and dimes (see CBOE 
Letter, supra note 5, at 2), while another commenter states its 
belief that a single break point for all classes will provide 
consistency for the industry and investors (see LiquidPoint Letter, 
supra note 5, at 3). The Commission does not believe that NYSE 
Arca's proposal will result in increased confusion. The Commission 
notes that the proposal will continue the same breakpoint as the 
existing Pilot, and thus changes to the structure of the Pilot will 
be minimal. See Ameritrade Letter, supra note 5, at 3 (noting that 
the current Pilot program carries a $3.00 breakpoint and thus 
changes to the pilot securities would be minimal, thus reducing any 
investor confusion related to the expansion of the Pilot).
    \46\ One commenter that supports retaining the $3 breakpoint 
noted that the majority of its customers' trades occur at or below 
the $3 breakpoint. This commenter believes that a $3 breakpoint is 
in the best interest of retail investors. See Ameritrade Letter, 
supra note 5, at 2-3 (stating that in April 2009, 71% of its 
customers' trades and 89% of its customers' volume was in series 
priced up to $3, and that in May 2009, 74% of its customers' trades 
and 88% of its customers' volume was in series priced up to $3). 
Another commenter that supports quoting in one-cent increments in 
all series in all options classes included in the Pilot believes 
that doing so would make the benefits of penny pricing available to 
more options. See GETCO Letter, supra note 5, at 3. Further, the 
Commission's Office of Economic Analysis estimates that, under NYSE 
Arca's proposal, approximately 70% of options contract volume would 
be quoted in one-cent increments. See OEA Memo 2, supra note 39.
     One commenter noted that if the Pilot were rolled back, as is 
proposed by several of the commenters, this would eliminate much of 
the benefit experienced by the options markets and customers due to 
the Pilot. See GETCO Letter, supra note 5, at 3. Another commenter 
similarly stated that a rollback of the Pilot would be 
``unfortunate'' given the benefits from the Pilot that participants 
have realized and recommended that the Pilot move forward. See BATS 
Letter, supra note 5, at 2.
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    One commenter stated its belief that NYSE Arca's proposal, which 
would be expanded to the next most-active, multiply-traded 300 classes, 
rather than all classes, does not provide a stringent process to renew 
names that will be eliminated from the Pilot due to delisting, merger 
or other circumstances, and that the proposal in this regard would 
represent an ongoing administration that would be costly to the 
commenter.\47\ The Commission notes that NYSE Arca's proposal 
explicitly includes a process for replacing, on a semi-annual basis, 
any Pilot class that has been delisted with the next most actively 
traded, multiply listed class that is not already included in the 
Pilot, based on trading activity in the previous six months.\48\ While 
there may be other approaches to address Pilot classes that have been 
delisted, none have been submitted to the Commission for its 
consideration. The Commission believes that NYSE Arca's proposal to 
replace delisted classes from the Pilot is reasonable and consistent 
with the Act.\49\
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    \47\ See Ameritrade Letter, supra note 5, at 3 (also noting its 
belief that the proposal would lead to investor confusion as it 
would not be representative of all classes).
    \48\ See Notice, supra note 4, at 4.
    \49\ One commenter believes the incidence of locked markets in 
Pilot classes has increased since the introduction of quoting in 
pennies. In addition, this commenter believes that an expansion of 
the Pilot could exacerbate the friction that it believes exists 
between competing payment models among the exchanges. The commenter 
believes that this issue could be mitigated if the Commission adopts 
the Linkage Plan. See Ameritrade Letter, supra note 5, at 2. The 
Commission notes that it approved the Linkage Plan on July 30, 2009. 
See Securities Exchange Act Release No. 60405, supra note 34. The 
commenter also urges the Commission to consider expanding the 
provisions of Rule 610 of Regulation NMS to options trading. See 
Ameritrade Letter, supra note 5, at 2. The Commission staff is 
currently considering the issue of access and access fees in the 
context of its ongoing consideration of a petition for rulemaking 
requesting that the Commission impose a cap of $.20 on certain 
transaction fees. See Letter from John C. Nagel, Managing Director & 
Deputy General Counsel, Citadel, to Nancy M. Morris, Secretary, 
Commission, dated July 15, 2008.
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    The Commission has published for comment proposed rule changes from 
CBOE and ISE that propose alternative approaches to expanding the 
Pilot.\50\ In recognition of these other proposals, several commenters 
express the view that uniformity is necessary for an expansion of the 
Pilot Program.\51\ These commenters argue that approval of multiple 
plans permitting exchanges to adopt different breakpoints would create 
confusion,\52\ and that a uniform approach is necessary to assure that 
there is a fair and orderly national market system.\53\ Several 
commenters state that adopting different penny pilot rules would cause 
technological and implementation problems for all participants in the 
National Market System, and that varied breakpoints will impact order 
entry, routing, quoting and compliance systems for each venue.\54\
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    \50\ See Securities Exchange Act Release Nos. 60018 (June 1, 
2009), 74 FR 27211 (June 8, 2009) and 60146 (June 19, 2009), 74 FR 
30346 (June 25, 2009).
    \51\ See, e.g., ISE Letter, supra note 5, at 1 and 3; Nasdaq 
Letter, supra note 5; SIFMA Letter, supra note 5, at 5-6; and UBS 
Letter, supra note 5, at 2.
    \52\ See, e.g., CBOE Letter, supra note 5, at 4; LiquidPoint 
Letter, supra note 5, at 2; and UBS Letter, supra note 5, at 2.
    \53\ See ISE Letter, supra note 5, at 1; and LiquidPoint Letter, 
supra note 5, at 2.
    \54\ See LiquidPoint, supra note 5, at 2-3; and Nasdaq Letter, 
supra note 5, at 2. Another commenter further states that multiple 
plans would subject members and ultimately investors to the elevated 
costs of excessive systems modifications and personnel training 
activities. See SIFMA Letter, supra note 5, at 6.
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    While the Commission agrees that a uniform approach may be 
preferable, the Commission must analyze each exchange's proposed rule 
change on its own merits for consistency with the Act. As discussed 
above, the Commission has analyzed NYSE Arca's proposal and finds that 
it is consistent with the Act. In this case, the Commission does not 
believe the choice of other exchanges to propose different quoting 
increments, or to not expand the current Pilot, makes NYSE Arca's 
proposed rule change inconsistent with the Act. The Commission notes, 
however, that if an options exchange chooses not to permit quoting in 
one-cent increments in a particular option at the same time as another 
exchange, it would nevertheless remain obligated to comply with the 
provisions of the Linkage Plan, as well as its own rules, to avoid 
trading at prices worse than those offered by other exchanges, 
including prices in pennies.

[[Page 49424]]

    The continued operation and phased expansion of the Pilot Program 
will provide further valuable information to the exchanges, the 
Commission, and others about the impact of penny quoting in the options 
market. In particular, extending and expanding the Pilot Program as 
proposed by NYSE Arca will allow further analysis of the impact of 
penny quoting in the Pilot classes over a longer period of time on, 
among other things: (1) Spreads; (2) peak quotation rates; (3) 
quotation message traffic; (4) displayed size; (5) ``depth of book'' 
liquidity; and (6) market structure. NYSE Arca has committed to provide 
the Commission with periodic reports, which will analyze the impact of 
the expanded Pilot Program. The Commission expects the Exchange to 
include statistical information relating to these factors in its 
periodic reports.

IV. Partial Accelerated Approval

    The Commission finds good cause, pursuant to Section 19(b)(2) of 
the Act,\55\ for partially approving the proposed rule change,\56\ as 
modified by Amendment Nos. 1 and 3 thereto, prior to the 30th day after 
the date of publication in the Federal Register. In its proposed rule 
change, the Exchange proposed that any option class included in the 
Pilot Program that has been delisted be replaced on a semi-annual basis 
by the next most actively traded, multiply listed options class that is 
not yet included in the Pilot, based on trading activity in the 
previous six months. In Amendment No. 1, the Exchange provided 
clarification that the Exchange will employ the same parameters to 
prospective replacement issues as approved and applicable under the 
Pilot Program, including the exclusion of high-priced underlying 
securities and indexes. In Amendment No. 3, the Exchange clarified that 
the threshold for ``high priced'' designation is $200 per share or a 
calculated index value of 200, at the time of selecting new issues to 
be included in the Pilot. The Exchange also represented that the 
threshold and the Exchange's approach for excluding high priced 
underlying securities is consistent with the Exchange's prior process 
in determining issues to be included in the Pilot. The Exchange stated 
that the determination of whether a security is trading above $200 or 
above a calculated index value of 200 shall be based on the price at 
the close of trading on the Expiration Friday prior to being added to 
the Pilot. These changes clarify the operation of the proposal and do 
not differ materially from the proposal as noticed in the Federal 
Register. Also, in response to commenters, in Amendment No. 1 the 
Exchange proposes to delay the start of the phased implementation of 
the expansion of the Pilot from July 28, 2009 to September 28, 2009. In 
Amendment No. 3 the Exchange proposed to begin the phased 
implementation on October 26, 2009. The proposed change to the 
implementation date is responsive to concerns expressed by commenters. 
Accordingly, the Commission finds that good cause exists to approve the 
proposed rule change, as modified by Amendment Nos. 1 and 3, on an 
accelerated basis.\57\
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    \55\ 15 U.S.C. 78s(b)(2).
    \56\ See supra 8 and supra note 9.
    \57\ In its proposed rule change, the Exchange proposed to quote 
SPY and IWM entirely in pennies. In Amendment No. 1, the Exchange 
stated that this proposed change to the minimum quoting increment in 
these classes would take place on September 28, 2009. The Commission 
notes, however, that it is not approving this aspect of the proposal 
in this order.
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V. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning Amendment Nos. 1 and 3, including whether 
Amendment Nos. 1 and 3 are consistent with the Act.
    The Commission also is soliciting additional comment on NYSE Arca's 
proposal to quote two classes entirely in pennies, SPY and IWM, in 
addition to QQQQs. In response to the initial notice of this 
proposal,\58\ the Commission received several comment letters with 
respect to the portion of the proposal that would allow quoting of all 
series of options on IWM and SPY in one-cent increments. One commenter 
supported NYSE Arca's proposal to eliminate a breakpoint for options on 
these two exchange-traded funds, as a way to expand the benefits of 
penny quoting to more options,\59\ while two other commenters did not 
support this aspect of NYSE Arca's proposal and question NYSE Arca's 
basis for the proposal.\60\ In particular, one commenter did not find 
persuasive NYSE Arca's rationale that because IWM and SPY have more 
series trading at premiums between $3 and $10, the $3 breakpoint should 
be eliminated, noting that only 11% of IWM's national average daily 
volume and 18% of SPY's national average daily volume is in series with 
premiums greater than $3.\61\
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    \58\ See Notice, supra note 4.
    \59\ See GETCO Letter, supra note 5, at 2-3.
    \60\ See CBOE Letter, supra note 5, at 2 to 3, and SIFMA Letter, 
supra note 5, at 5.
    \61\ See CBOE Letter, supra note 5, at 3. This commenter further 
noted that the average spread width in series with a premium $3 or 
greater is $0.27 for SPY and $0.25 for IWM. Id.
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    The Commission's Office of Economic Analysis estimated that for a 
four month period earlier this year, approximately 40.9 million 
contracts for SPY and approximately 4.5 million contracts for IWM 
traded at premia of $3 or greater, as compared to approximately 2.7 
million contracts for QQQQ that traded at premia of $3 or greater.\62\ 
The Commission specifically requests comment on these findings.
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    \62\ See OEA Memo 2, supra note 40 (measuring from February 2, 
2009 to May 27, 2009). These numbers represent approximately 29% of 
contract volume for SPY and 18% of contract volume for IWM.
---------------------------------------------------------------------------

    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-2009-44 on the subject line.

Paper Comments

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

All submissions should refer to File Number SR-NYSEArca-2009-44. 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 such filing also will be available for 
inspection and copying at the principal office of the Exchange. 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 49425]]

submissions should refer to File No. SR-NYSEArca-2009-44 and should be 
submitted on or before October 19, 2009.

VI. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\63\ that the proposed rule change (SR-NYSEArca-2009-44) as 
modified by Amendment Nos. 1 and 3 thereto, be, and hereby is, 
partially approved on an accelerated basis, as discussed above.
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    \63\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\64\
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    \64\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. E9-23374 Filed 9-25-09; 8:45 am]

BILLING CODE 8010-01-P
