
[Federal Register Volume 77, Number 164 (Thursday, August 23, 2012)]
[Notices]
[Pages 51088-51097]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-20714]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-67683; File No. SR-Phlx-2012-105]


Self-Regulatory Organizations; NASDAQ OMX PHLX LLC; Notice of 
Filing of Proposed Rule Change Regarding Treasury Securities Options

August 17, 2012.
    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 August 7, 2012, NASDAQ OMX PHLX LLC (``Phlx'' or ``Exchange'') filed 
with the Securities and Exchange Commission (``SEC'' or ``Commission'') 
the proposed rule change as described in Items I, II and III, below, 
which Items have been prepared by the Exchange. 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.
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I. Self-Regulatory Organization's Statement of the Terms of the 
Substance of the Proposed Rule Change

    The Exchange is filing with the Securities and Exchange Commission 
(``Commission'') a proposal to implement twenty-five new rules in the 
1000D Series of rules so that the Exchange may list options on Treasury 
securities \3\ and allow trading thereon.\4\
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    \3\ Subsection (a)(1) of proposed Rule 1001D states that the 
term ``Treasury securities'' (also known as Treasury debt 
securities) means a bond or note or other evidence of indebtedness 
that is a direct obligation of, or an obligation guaranteed as to 
principal or interest by, the United States or a corporation in 
which the United States has a direct or indirect interest (except 
debt securities guaranteed as to timely payment of principal and 
interest by the Government National Mortgage Association). 
Securities issued or guaranteed by individual departments or 
agencies of the United States are sometimes referred to by the title 
of the department or agency involved (e.g. a ``Treasury security'' 
is a debt instrument that is issued by the United States Treasury).
    \4\ Exchange listing and trading rules are organized as noted. 
Generally, rules applicable to equity and currency options can 
currently be found at Rule 1000 et seq.; rules applicable to index 
options can be found at Rule 1000A et seq.; rules applicable to cash 
index participations can be found at Rule 1000B et seq.; and rules 
applicable to PHLX Forex Options can be found at Rule 1000C et seq. 
Rules applicable to Treasury security options are being proposed at 
Rule 1000D et seq.
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    The text of the proposed rule change is available on the Exchange's 
Web site at http://www.nasdaqtrader.com/micro.aspx?id=PHLXRulefilings, 
at the principal office of the Exchange, and at the Commission's Public 
Reference Room.

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

    In its filing with the Commission, the Exchange 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. The Exchange 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 the 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    The purpose of this filing is to implement Exchange Rules 1000D 
through 1025D (the ``1000D Series''), which would, in conjunction with 
current applicable Exchange rules and procedures, allow the Exchange to 
list options on Treasury securities (``Treasury securities options''). 
The Exchange could then allow trading on Treasury securities options.
Background
    Treasury securities are direct debt obligations issued by the U.S. 
government that are used by the government to raise capital and/or make 
payments on outstanding debt and by traders and investors, both in the 
underlying form and as derivatives proposed by this filing, as trading, 
investing, and hedging vehicles. Since Treasury securities are backed 
by the full faith and credit of the U.S. government, they are generally 
considered to have low risk and typically carry lower yields than other 
debt securities. Marketable Treasury securities are initially sold in a 
scheduled auction process and thereafter trade in a secondary market 
that is recognized as among the most liquid and extensively reported in 
the world.
    The Exchange believes that the prices of Treasury securities are 
widely disseminated, active, and visible to traders and investors. In 
addition, the Exchange intends to get real-time Treasury prices (data) 
from a market data provider so that it can use this data in support of 
the Exchange's market, regulatory and surveillance operations. The 
Exchange intends to use this data for the purpose of opening and 
determining settlement values for Treasury options. Thirty days prior 
to the start of trading the Exchange would make an announcement, via an 
Options Trader Alert (``OTA''), to its member organizations regarding 
the details of the proposed real-time Treasury price offering.\5\
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    \5\ On the basis of the real-time Treasury data that the 
Exchange is able to get, it is considering offering an alternative 
Treasury data feed to those Exchange members that may desire to 
acquire such data from the Exchange. As the Exchange notes in the 
proposal, however, Treasury data is readily available to the 
investing public from numerous sources including broker dealers. 
Based on a review of many broker/dealers offering Treasury 
securities to their customers, the Exchange believes that broker 
dealers typically do not offer new options classes to customers for 
trading unless these brokers have an ability to provide transparent, 
real-time prices for the underlying in addition to options chains.
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    The secondary market for Treasury securities is an over-the counter 
(``OTC'') market in which participants trade with one another on a 
bilateral basis rather than on an organized exchange (Treasury 
securities can trade at the New York Stock Exchange, but trading in 
that market is negligible). Trading activity takes place between 
primary dealers; non-primary dealers; and customers of these dealers, 
including financial institutions, nonfinancial institutions, and 
individuals. There are a variety of databases providing bond 
information, including information regarding the listing and/or trading 
location of a bond, such as, for example, Govpx, Standard

[[Page 51089]]

& Poor's Bond Guide, the Mergent Bond Record, First Data Services' 
BORAS, Bloomberg, and the Commission's EDGAR internet service.\6\ 
Whereas options on Treasury securities will be cleared by The Options 
Clearing Corporation (``OCC'') as discussed, the underlying securities 
will be cleared at the National Securities Clearing Corporation 
(``NSCC'') or the Fixed Income Clearing Corporation (``FICC''), as 
applicable.
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    \6\ The prices of Treasury Securities are widely disseminated, 
active and visible. There is a high level of price transparency for 
Treasury securities because of extensive price dissemination to the 
investing public (e.g. commercial and investment banks, insurance 
companies, pension funds, mutual funds, and retail investors) of 
price information by information vendors. These information vendors 
include an industry-sponsored corporation, Govpx, that disseminates 
price and real-time trading volume information for Treasury 
securities via interdealer broker screens.
     Moreover, retail brokers (e.g. Fidelity, TD Ameritrade, 
E*TRADE, Charles Schwab, Interactive Brokers, and Scottrade) offer 
market access and the ability to purchase and sell Treasury 
securities on a real time basis, similarly to equity securities. For 
example, on May 8, 2012, Fidelity Investments displayed live bid/ask 
quotes with size offered on its retail brokerage Web site for the 
current on-the-run 30-YR Treasury bond (the 3.125% bond due February 
15, 2042) and the previous seventeen issued on-the-run 30-YR 
Treasury bonds starting with the due date of February 15, 2036. On-
the run Treasury securities are generally the most recently issued 
U.S. Treasury bonds or notes of a particular maturity. The Exchange 
believes that the majority of broker/dealers in the U.S. offer 
readily available on-the-run Treasury prices.
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    This filing would allow the Exchange, as permissible by rule on 
other options exchanges,\7\ to list and trade standardized options \8\ 
on two specific types of marketable on-the-run Treasury securities 
issued by the Treasury: notes and bonds.\9\ These options overlie 
individual underlying Treasury securities. Such options having a 
specifically identified underlying Treasury security will be known as 
``specific cusip options.'' Similarly to equity and index options, 
these would be required to be delivered upon exercise.\10\
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    \7\ See Chicago Board Options Exchange (``CBOE'') rules 21.1-
21.31. See also Securities Exchange Act Release No. 18371 (December 
23, 1981), 46 FR 63423 (December 31, 1981) (SR-Amex-81-1; SR-CBOE-
81-27) (order initially approving CBOE and Amex (now NYSE Amex) to 
list and trade options contracts on securities issued by the U.S. 
Treasury). The Exchange does not believe that currently these 
markets list options on debt securities issued by the U.S. Treasury 
or Government.
    \8\ Standardized options are options contracts trading on a 
national securities exchange, an automated quotation system of a 
registered securities association, or a foreign securities exchange 
that relate to options classes the terms of which are limited to 
specific expiration dates and exercise prices, or such other 
securities as the Commission may, by order, designate. 17 CFR 
240.9b-1(a)(4). Standardized options are cleared by the OCC, which 
takes the position of counter-party in such transactions.
    \9\ Subsections (a)(2) and (a)(3) of proposed Rule 1001D, 
respectively. Other types of marketable securities issued by the 
Treasury (e.g. Treasury Inflation Protected Securities or TIPS) and 
non-marketable Treasury securities (e.g. government savings bonds) 
are not instruments that may underlie options for listing and 
trading.
    \10\ Subsection (a)(4) of proposed Rule 1001D.
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    The Exchange specifically limits its proposal to listing options on 
on-the-run Treasury securities.\11\ Because on-the-run (as opposed to 
off-the-run) Treasury securities are most recently issued U.S. Treasury 
bonds or notes and are most frequently traded securities of a maturity, 
they are extremely liquid and afford excellent price discovery.\12\ 
Being the most liquid, on-the-run Treasury securities typically are a 
little bit more expensive and yield less than their off-the-run 
counterparts; when market commentators quote price or yield of Treasury 
securities, they generally refer to on-the-run Treasury securities.\13\ 
As we have discussed, the prices of Treasury securities, particularly 
those that are on-the-run, are readily quoted and offered by numerous 
public sources and broker dealers; and, the prices are also available 
from exchanges that trade derivatives on Treasuries.\14\
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    \11\ Proposed Rule 1006D.
    \12\ Upon completion of a Treasury auction, the most recently 
issued note or bond becomes on-the-run and the previous on-the-run 
issue goes off-the-run. The Exchange will only offer options that 
overlie the extremely liquid on-the-run Treasury securities, whose 
prices are readily available and are quoted by the media and various 
informational Web sites.
    \13\ For additional information about on-the run Treasury 
securities, see http://www.investopedia.com/terms/o/on-the-runtreasuries.asp#axzz1zlFBaVZT. The Treasury department uses on-
the-run Treasury securities values to calculate daily yield curve 
rates at http://www.treasury.gov/resource-center/data-chart-center/interest-rates/pages/textview.aspx?data=yield.
    For a recent academic study that uses on-the-run Treasury 
securities because of their liquidity, see Government Intervention 
and Strategic Trading in the U.S. Treasury Market, by Paolo 
Pasquariello, Jennifer Roush, and Clara Vega, June 2012. 
Pasquariello, Roush and Vega note that they specifically ``* * * 
focus on on-the-run issues because those securities display the 
greatest liquidity and informed trading.'' See also Measuring 
Treasury Market Security, by Michael J. Fleming, FRBNY Economic 
Policy Review/September 2003 (``Even though on-the-run securities 
represent just a small fraction of the roughly 200 Treasury 
securities outstanding, they account for 71 percent of activity in 
the interdealer market * * *''); and The Transition to Electronic 
Communications Networks in the Secondary Treasury Market, by Bruce 
Mizrach and Christopher J. Neely, Federal Reserve Bank of St. Louis 
Review, November/December 2006 (``There is much more secondary 
volume in on-the-run securities than off-the-run securities, with 
the former representing 70 percent of all trading volume[hellip]'').
    \14\ See, for example, Chicago Mercantile Exchange Group 
(``CME'') offering futures as well as options on Treasury 
securities, at http://www.cmegroup.com/trading/interest-rates/on-the-run-us-treasury-futures.html. CME Treasury futures volumes in 
the year 2011 include: 315,903,050 contracts on the 10 year Treasury 
note; and 92,065,406 contracts on the 30 year Treasury bond. The 
Exchange notes that while proposed Treasury options would have a 
face value of $10,000 per contract (proposed Rule 1008D), CME 
futures products have a face value of $100,000.
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    The secondary Treasury securities market that would underlie the 
proposed Treasury options is clearly one of the biggest, most liquid 
securities markets in the world. This is indisputable and supported by 
the huge trading volumes of Treasury securities, as discussed below. In 
their 2012 study, Pasquariello, Roush, and Vega, state regarding their 
study of the secondary market for U.S. Treasury notes and bonds: ``The 
secondary market for these securities is among the largest, most liquid 
financial markets * * * [a]verage trading volumes are high and quoted 
bid-ask spreads are small * * *'' We note the highly liquid nature of 
the Treasury securities market is similar to the highly liquid nature 
of the foreign exchange market, where the Commission recently approved 
the listing of options on foreign exchange (``forex'') currencies 
(``PHLX FOREX options'').\15\ In 2010 and 2011, for example, according 
to SIFMA, the average daily trading volume (notional value) of Treasury 
securities traded by primary dealers was $528.2 Billion and $576.8 
Billion respectively, and in 2010, according to the BIS Triennial 
Survey, the average daily turnover (notional value) of the forex market 
was $4.0 Trillion.\16\ The Exchange strongly believes that just as the 
Commission approved options overlying the very liquid forex market, so 
it should approve proposed options overlying the correspondingly liquid 
Treasury market.
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    \15\ See Securities Exchange Act Release No. 66616 (May 16, 
2012), 77 FR 16879 (May 22, 2012) (SR-Phlx-2012-11) (order approving 
listing FOREX options on Phlx). In the approval order, the 
Commission noted the liquidity of the forex markets underlying the 
PHLX FOREX options proposed by the Exchange. The Exchange notes that 
the appropriate dates for the citation are March 16, 2012 and March 
22, 2012, respectively. See email from Jurij Trypupenko, Phlx, to 
Michael Gaw, Assistant Director, and Adam Moore, Attorney Advisor, 
Division of Trading and Markets, Commission, dated August 15, 2012.
    \16\ See http://www.sifma.org/research/statistics.aspx and 
http://www.bis.org/publ/rpfx10.htm.
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    The Exchange believes that the ability to trade standardized 
options overlying Treasury securities as proposed in this filing would 
serve an important economic function. In particular, such options could 
be used by a wide range of investors and traders that may be sensitive 
to, among other things, the potential price risk of alternative 
underlying securities and interest rate changes. Through the use of 
various option purchasing, writing (selling), and combination 
strategies, investors and

[[Page 51090]]

traders would be able to use options on Treasury securities as short 
and long-term investment vehicles; as viable alternatives to 
potentially more risky derivative vehicles; and as a hedge against 
equity, option, or other security positions or against the risks 
associated with inverse interest rate movements while retaining the 
opportunity to profit from favorable movements.
    The Exchange contends that trading Treasury securities options on 
the Exchange, as proposed, offers several distinct benefits.\17\ First, 
options on Treasury securities would be traded in a highly regulated 
and transparent exchange environment. Second, as a result of the 
standardization of Treasury securities option contracts in conjunction 
with quoting and market making requirements, such option contracts 
should develop more liquid and deeper markets. Third, counterparty 
credit risk would be mitigated because the contracts would be issued 
and guaranteed by the OCC. And fourth, the quotation and last-sale data 
provided by the Exchange to the options processor, Options Price 
Reporting Authority (``OPRA''), and its members would lead to more 
transparent markets. The Exchange believes that expanding the universe 
of listed products available to market participants interested in 
Treasury securities options by listing such options on the Exchange 
could significantly increase competition with other exchanges that have 
the capability to list and trade derivatives on Treasury securities 
\18\ as well as with the OTC market.\19\
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    \17\ The Exchange currently allows the trading of certain 
options that may reference Treasury Securities. Commentary 
.09(a)(iv) to Rule 1009 states that securities deemed appropriate 
for options trading currently include shares or other securities 
including Fixed Income Index-Linked Securities (``Fixed Income 
ILS''). Fixed Income ILS are described as securities that provide 
for the payment at maturity of a cash amount based on the 
performance or the leveraged (multiple or inverse) performance of 
one or more notes, bonds, debentures or evidence of indebtedness 
that include, but are not limited to, U.S. Department of Treasury 
securities, government-sponsored entity securities, municipal 
securities, trust preferred securities, supranational debt and debt 
of a foreign country or a subdivision thereof or a basket or index 
of any of the foregoing (``Fixed Income Reference Asset'').
    \18\ For example, as noted CME lists futures and options on 
futures on Treasury securities (and other debt instruments). CBOE 
lists options on exchange traded funds and other vehicles that are 
invested in Treasury securities.
    \19\ Exchange listed options are viewed as a viable, liquid 
alternative to OTC options. This is, as discussed, because exchange 
listed options do not possess the negative characteristics often 
associated with non-exchange listed (OTC) options, such as lack of 
transparency; counterparty risk; and insufficient regulation, 
clearing arrangements, collateral requirements, and trade 
processing. The Exchange/OTC market distinction and the safeguards 
of central clearing and SRO regulation have become particularly 
evident and significant in the recent economic downturn.
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Exchange Rules Are Applicable
    The Exchange establishes the controlling principle that its 
existing rules and procedures are applicable to options on Treasury 
securities and the proposed rules would supplement existing Exchange 
rules. Proposed Rule 1000D states that unless otherwise specified, the 
rules in the 1000D Series are applicable only to options on Treasury 
securities. The rule states further that except to the extent that 
specific rules in the 1000D Series govern, or unless the context 
otherwise requires, the provisions of the Option Rules applicable to 
equity options \20\ and of the By-Laws \21\ and all other Rules and 
Policies of the Board of Directors \22\ (together referred to as 
``current Exchange rules'') are applicable to the trading on the 
Exchange of options on Treasury securities. The Exchange underscores 
the general controlling principle that current Exchange rules are 
applicable by referring to current option rules in certain proposed 
Treasury securities options rules.\23\
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    \20\ Option Rules 1000 et seq.
    \21\ By-Laws Articles I to VII.
    \22\ Rules of the Exchange Rule 1 et seq. and Options Floor 
Procedure Advices.
    \23\ For example, proposed Rule 1004D refers to current Rules 
1001 regarding position limits, 1003 regarding reporting of options 
positions, and 1004 regarding liquidation of positions. Proposed 
Rules 1011D and 1012D refer to current Rule 1047 regarding trading 
rotations, halts and suspensions. Proposed Rule 1014D refers to 
current Rule 1014 regarding obligations and restrictions applicable 
to specialists and Registered Options Traders (``ROTs''; specialists 
and ROTs are defined in Rules 1020 and 1014(b)(i), respectively), 
and Rule 1080 regarding electronic trading via Phlx XL and XL II. 
Proposed Rule 1015D refers to current Rule 1059 regarding 
accommodation trading. Proposed Rule 1019D refers to current Rule 
1014 regarding obligations and restrictions applicable to 
specialists and bid/ask differentials. Proposed Rule 1020D refers to 
current Rule 1043 regarding exercise assignment notices. Proposed 
Rule 1022D refers to Rule 721 regarding margin.
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    Treasury securities options will generally trade on the Exchange's 
electronic options platform, Phlx XL \24\ and settle like equity 
options on the Exchange. As noted, therefore, Exchange rules applicable 
to equity options trading will be applicable to Treasury securities 
options unless there is a specific rule in the 1000D Series to the 
contrary or a proposed rule supplements an existing rule.
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    \24\ See Securities Exchange Act Release No. 59995 (May 28, 
2009), 74 FR 26750 (June 3, 2009) (SR-Phlx-2009-32) (order approving 
Phlx XL II).
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    Treasury securities options will be physically settled, European-
style options that may be exercised only on the day that they 
expire.\25\ Trading in Treasury securities options ordinarily will 
cease on the business day (usually a Friday) preceding the expiration 
date. Trading hours will correspond to the hours during which equity 
options are normally traded on the Exchange, which currently are 9:30 
a.m. to 4:00 p.m. ET.\26\ The expiration date will be the Saturday 
immediately following the third Friday of the expiration month.\27\
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    \25\ Proposed Rule 1008D(c).
    \26\ Proposed Rule 1010D. For trading hours on the Exchange, see 
Rule 101.
    \27\ Specifications for options on Treasury securities may be 
found at www.nasdaqtrader.com.
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Definitions
    Definitions applicable to Treasury securities and options on them 
are found in proposed Rule 1001D. Regarding products underlying options 
to be traded on the Exchange subsection (a)(1) states that ``Treasury 
securities'' represent a bond or note, or other evidence of 
indebtedness that is a direct obligation of, or an obligation 
guaranteed as to principal or interest by, the United States or a 
corporation in which the United States has a direct or indirect 
interest.\28\ Next, the terms ``bond'' and ``note'' are defined. 
Subsection (a)(2) of proposed Rule 1001D states that Treasury notes are 
interest-bearing debt instruments issued by the U.S. Treasury with a 
term to maturity of at least two years but no more than ten years at 
the time of original issuance. Subsection (a)(3) states that Treasury 
bonds are interest-bearing debt instruments issued by the U.S. Treasury 
with a term to maturity of more than ten years at the time of original 
issuance.
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    \28\ See supra note 3.
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    The Exchange establishes two exercise price definitions in proposed 
Rule 1001D: exercise price and aggregate exercise price.\29\ The 
Exchange also establishes the concept of a covered short call and put 
position in Treasury securities options.\30\
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    \29\ Subsections (a)(5) and (a)(6) of Rule 1001D, respectively, 
state: ``Exercise price'' in respect of a specific cusip option 
means the specified price at which the underlying Treasury security 
may be purchased or sold upon the exercise of the option contract. 
``Aggregate exercise price'' in respect of a specific cusip option 
means the exercise price of an option contract multiplied by the 
principal amount of the underlying Treasury security covered by the 
option.
    \30\ Subsection (a)(7) of rule 1001D states: The term 
``covered'' in respect of a short position in a Treasury security 
call option contract means that the writer holds in the same account 
on a principal for principal basis: (1) A long position in 
underlying Treasury securities that qualify for delivery upon 
exercise; (2) a long Treasury securities call option position for 
the same underlying security as the short call position where the 
expiration date of the long call position is the same as or 
subsequent to the expiration date of the short call position and the 
exercise price(s) of the long call position is equal to or less than 
the exercise price of the short call position; or (3) a custodial or 
Treasury securities escrow receipt pursuant to Rule 1022D.
     The term ``covered'' in respect of a short position in a 
Treasury security put option contract means that the writer holds in 
the same account on a principal for principal basis: (1) a long 
Treasury security put option position for the same underlying 
security as the short put position where the expiration date of the 
long put position is the same as or subsequent to the expiration 
date of the short put position and the exercise price(s) of the long 
put position is equal to or greater than the exercise price of the 
short put position or (2) a Treasury security put guarantee letter 
pursuant to Rule 1022D.

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Designation and Commencement of Trading
    Treasury securities options will use a convention for describing 
(designating) options that is uniquely adapted to the nature of such 
options. Specifically, proposed Rule 1005D states that Treasury options 
purchased and sold on the Exchange will be designated by reference to 
the issuer of the underlying Treasury security, principal amount, 
expiration month (and year for the longest term option series), 
exercise price, type (put or call), stated rate of interest, and stated 
date of maturity or nominal term to maturity. For example, a specific 
cusip call option expiring in March and having an exercise price of 96 
of the $10,000 principal amount of a 3 \3/4\% Treasury bond that 
matures on August 15, 2041, would be designated as a Treasury 3 \3/
4\%--8/15/41 March 96 call.
    Regarding specific cusip Treasury security options, subsection (a) 
to proposed Rule 1009D states that at any time after an auction sale of 
an underlying Treasury security, if the Exchange decides to initially 
open options for trading the Exchange shall open a minimum of one 
expiration month and series for each class of options.\31\ These 
options are opened only on settled, on-the- run Treasury securities 
pursuant to the ``options listing timeframe'' concept established in 
Rule 1006D.\32\ The Exchange notes that while the ``options listing 
timeframe'' concept is specific to Treasury securities options, the 
minimum one expiration month and one series requirement is wholly 
consistent with a similar requirement for other options traded on the 
Exchange.\33\
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    \31\ A single Treasury security option covers $10,000 principal 
amount of the underlying security. Proposed Rule 1008D.
    \32\ Proposed Rule 1006(a)(2) establishes that the ``options 
listing timeframe'' is when an underlying Treasury security is 
settled and on-the-run. In Exhibit 1 of the Form 19b-4 provided by 
the Exchange, the Exchange used the term ``opening time frame'' in 
several places in this discussion. Per the request of the Exchange, 
the term ``opening time frame'' has been replaced with ``options 
listing frame'' in this Notice. See email from Jurij Trypupenko, 
Phlx, to Michael Gaw, Assistant Director, and Adam Moore, Attorney 
Advisor, Division of Trading and Markets, Commission, dated August 
15, 2012.
    \33\ See Rules 1012 (stock and ETF options) and 1101A (narrow 
and broad-based index options).
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    Additional series may also be opened when the Exchange deems it 
necessary to maintain an orderly market, to meet customer demand or to 
reflect substantial changes in the prices of underlying Treasury 
securities. These series are opened pursuant to the ``additional 
series'' concept established in Rule 1006D.\34\ The Exchange will give 
notice that it is opening any such additional options.\35\
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    \34\ Proposed Rule 1006D(a)(2) establishes that additional 
series of specific cusip Treasury options may be opened only within 
the ``options listing timeframe.'' While the ``options listing 
timeframe'' concept is specific to Treasury securities options, the 
series add procedure is otherwise similar to the process for adding 
other option series on the Exchange. See Rule 1012 in respect of 
equity and ETF options. As discussed, the exercise price of an 
option must be reasonably close to the price at which the underlying 
security is traded in the primary market at the time the series of 
options is first opened for trading. Proposed Rule 1008D.
    \35\ The Exchange generally provides notice via OTA or the 
Exchange Web site.
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Terms and Criteria for Listing and Trading
    The Exchange proposes rules setting forth the initial and continued 
(maintenance) listing standards for Treasury securities options.
    Specifically, subsection (a) of proposed Rule 1006D states that 
Treasury securities may be initially approved by the Exchange as 
underlying securities for Exchange transactions in specific cusip 
options, subject to requirements as to size of original issuance, 
aggregate principal amount outstanding, and years to maturity.
    Additionally, the following factors must be met:
    (1) The original public sale of an underlying Treasury security 
shall be at least $1 billion principal amount.
    (2) In order to limit underlying Treasury securities that are 
approved for specific cusip options listings to the most recently 
issued and actively traded Treasury securities, Exchange approval of a 
Treasury security underlying Treasury options will only extend to the 
settled on-the-run Treasury security (``options listing timeframe''). 
However, the Exchange shall not approve a subsequent settled on-the-run 
Treasury security until after the expiration of all the options that 
are listed pursuant to the preceding options listing timeframe.
    Moreover, any additional series of specific cusip Treasury options 
overlying the settled, on-the-run Treasury security may be opened only 
within the options listing timeframe.\36\
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    \36\ Provided that, in respect of this second requirement, such 
approval may be extended in the event of the reopening of the 
underlying security by the Treasury, or in the event of issues where 
a reasonably active secondary market exists. Further, even prior to 
the end of such options listing timeframe and additional series, the 
Board (or a designee of the Board) shall withdraw approval of an 
underlying Treasury security at any time if it determines on the 
basis of information made publicly available by the Treasury that 
the security has a public issuance of less than $750 million, 
excluding stripped securities. Proposed Rule 1006D(a)(2).
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    Proposed Rule 1006D establishes several principals. First, the 
proposed ``options listing timeframe'' of a Treasury security on which 
Treasury options may overlie always coincides with the on-the-run 
period for the Treasury security, once such option is settled.\37\ This 
establishes that a Treasury security is eligible for listing of options 
only during its most liquid on-the run period. Second, options on a 
newly settled (subsequent) on-the-run Treasury security can only be 
listed after all the options that are listed pursuant to the preceding 
options listing timeframe expire. This minimizes or negates overlap and 
proliferation of Treasury options. As discussed, an on-the run Treasury 
security (e.g. 30 year bond) in the options listing timeframe becomes 
off-the-run when there is a subsequent auction for the Treasury 
security and as a result the newly settled security becomes on-the-run. 
The Exchange will not list options on the subsequent on-the-run 
Treasury security until all options listed within the options listing 
timeframe on the immediately preceding on-the-run Treasury security 
(which has become off-the-run) expire. Third, after options are 
initially listed in an options listing timeframe, any additional series 
of options may only be opened within the same options listing 
timeframe. Thus, new series of options may not be opened outside an 
options listing timeframe.
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    \37\ Currently, Treasury securities are settled within 
approximately a week after an auction occurs.
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    As an example, assume that for the 3.00% 30-year Treasury bond that 
matures on May 15, 2042, the on-the-run period would be the three 
calendar months of June, July, and August.\38\ The auction for the 30-
year bond would take place in June and the bond would settle within a 
week of the auction. This settled on-the-run period represents the 
``options listing timeframe'' for the 30-year Treasury bond that the 
Exchange

[[Page 51092]]

can then list options on.\39\ Thus, overlying the settled 30-year 
Treasury bond in the options listing timeframe, the Exchange could 
determine to initially list the following options: the Treasury 3.00%--
5/15/42 June 99 call, 100 call, and 101 call, as well as three put 
strikes. And, within the options listing timeframe the Exchange could 
determine to list additional series as a 102 call and a 103 call. These 
options are within the limitations set forth in proposed Rule 1006D, 
which allows the Exchange to list Treasury options only on settled on-
the-run Treasury securities, that is, within the options listing 
timeframe; and allows the Exchange to open additional series of options 
as long as they are within the options listing timeframe.
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    \38\ This is a typical on-the-run period for a Treasury 
security.
    \39\ Proposed Rule 1006D(a)(2).
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    Proposed Rule 1007D states in subsection (a) that the Board (or a 
designee of the Board) may determine, for any reason, to withdraw 
approval of any Treasury securities that were initially approved for 
options trading pursuant to Rule 1006D as underlying securities.\40\ 
Subsection (b) states that after any announcement by the Exchange of 
such withdrawal of approval, each member organization shall, if 
requested by a customer to effect an option transaction in such 
Treasury securities, inform such customer of the withdrawal of approval 
prior to affecting any transactions in such securities.
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    \40\ As with other options products (e.g. equity options, index 
options), Treasury security options that are no longer approved but 
have open interest would remain open for closing transactions only 
so that the open interest can trade out or expire.
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Minimum Price Variation and Bids and Offers
    Proposed Rule 1013D discusses minimum increment and the unique 
meaning of bids and offers for options on Treasury securities. 
Specifically, subsection (a) provides that Treasury securities options 
shall have a minimum increment of $.01. Subsection (b) similarly 
provides that bids and offers for Treasury securities options shall be 
expressed in $.01 increments. The Exchange believes that the proposed 
$.01 increments are uniform and particularly appropriate for Treasury 
securities options to allow traders to make the most effective use of 
the product for trading and hedging purposes. The Exchange believe 
further that the proposed $.01 increments will not cause any capacity 
problems.
    Penny increments have been used very effectively for more than five 
years on the Exchange as well as on other options markets. First, the 
Commission has approved the use of penny increments pursuant to the 
Penny Pilot, pursuant to which some of the highest-volume options trade 
in penny increments for series of options less than $3.00.\41\ Second, 
the Commission has approved the use of penny increments for certain 
categories of products on the Exchange such as, for example, foreign 
currency options (FCOs, also known as World currency Options or 
WCOs).\42\ Third, the Commission has approved the use of penny 
increments for specific option products on the exchange such as Alpha 
Index Options.\43\ Fourth, the Commission has approved penny increments 
for various option products traded on other exchanges.\44\ As such, the 
Exchange believes that penny increments are proper for Treasury 
securities options and represents that it has the necessary system 
capacity to support any additional Treasury securities option series 
that are listed pursuant to this proposal.
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    \41\ These include the highest-volume options overlying the 
PowerShares QQQ Trust (QQQQ)[supreg], the SPDR S&P 500 Exchange 
Traded Funds (SPY), and the iShares Russell 2000 Index Funds (IWM) 
which, unlike other Penny Pilot options, trade at penny increments 
regardless of the price (the Penny Pilot establishes $.05 increments 
where the price is $3.00 or higher). See Securities Exchange Act 
Release No. 55153 (January 23, 2007), 72 FR 4553 (January 31, 
2007)(SR-Phlx-2006-74)(notice of filing and approval order 
establishing Penny Pilot); and Rule 1034. All other options 
exchanges have similar penny pilot programs.
     The Exchange notes that the Penny Pilot has structural 
limitations that make it wholly inappropriate for Treasury 
securities options. The Penny Pilot is, for example: (a) Available 
only for a limited number of equity, index, and ETF options, and all 
of the available slots are already used; (b) designed to be used by 
other exchanges that have similar pilots to multiply list and trade 
options, but as noted all other penny pilot markets do not have 
rules that would allow them to list Treasury securities options; and 
(c) is severely limited in terms of price below $3.00.
    \42\ See Securities Exchange Act Release No. 60169 (June 24, 
2009), 74 FR 31782 (July 2, 2009) (SR-Phlx-2009-40) (order approving 
listing and trading of FCOs or WCOs at penny increments); and Rule 
1034.
    \43\ See Securities Exchange Act Release No. 63860 (February 7, 
2011), 76 FR 7888 (February 11, 2011)(SR-Phlx-2010-176) (order 
approving listing and trading Alpha Index Options); and Rule 1034.
    \44\ See Exchange Act Release Nos. 64991 (July 29, 2011), 76 FR 
47280 (August 4, 2011) (SR-CBOE-2011-039) (order approving listing 
and trading single stock dividend options in penny increments); 
63352 (November 19, 2010), 75 FR 73155 (November 29, 2011)(SR-CBOE-
2011-046) (order approving amendments regarding credit default 
options, including penny increments); 31169 (May 22, 2008), 73 FR 
31169 (May 30, 2008) (SR-CBOE-2006-105) (order approving listing and 
trading binary options on broad-based securities in penny 
increments); and 58486 (September 8, 2008), 73 FR 53298 (September 
15, 2008) (SR-ISE-2008-36) (notice and filing and immediate 
effectiveness proposing to permit ISE members to enter non-displayed 
electronic orders and quotes in penny increments, citing to SR-CBOE-
2007-39 and SRNASDAQ-2007-004 and SR-NASDAQ-2007-080). See also NYSE 
Arca Equities Rule 7.6, Commentary .03, which indicates that the 
minimum price variation for quoting and entry of orders in equity 
securities traded on Arca is $.01, with the exception of securities 
that are priced less than $1.00 for which the MPV for order entry is 
$0.0001.
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    It is clear that inadequately narrow Treasury securities option 
intervals negatively impact trading and hedging opportunities.
    As an example, if the increments were set at another interval level 
such as $0.50 instead of the proposed $0.01, and an investor wanted to 
spend no more than $375 to buy a down-side hedge with a put option on a 
Treasury bond currently trading 102.00, the investor would have the 
following strikes available from which to chose: an at-the-money 
(``ATM'') 102 put and an out-of-the-money (``OTM'') 101 put. If the 
bid/ask quote for the ATM 102 put was $350/$400, then the investor may 
elect not to pay $400 and may subsequently choose the lower OTM 101 
put. Even if the resulting 101 put had a bid/ask of $200/$250, thereby 
allowing the investor to make a purchase for less than $375, the 
investor would have a different risk/reward scenario because the lower 
put would not represent an ATM hedge. Accordingly, the investor would 
have to carry the Treasury bond position with risk of market movement 
down to the 101 strike before the put becomes an ATM put. If, on the 
other hand, the proposed $0.01 intervals were effective, and the same 
investor had a choice of the same strikes from which to choose (an ATM 
102 put and an OTM 101 put), at $0.01 intervals the premium cost for a 
hedge using the ATM 102 put may be about $359 to $360. This would 
garner the investor as much as a $40 or 10% savings in the cost to put 
on the desired hedge. The proposed interval range would clearly be very 
advantageous to investors; and would be costly if not available.
    And as yet another example, if an investor were interested in 
purchasing a complex option spread, narrow option intervals would offer 
additional cost savings and choice. Using the noted 102 and 101 put 
example, an investor may choose to purchase (go long) a put spread as a 
hedge; this would be a complex order where the investor would buy the 
higher strike and simultaneously sell the lower strike for a debit. If 
the strike price increments were set at $0.50 and an investor wanted to 
spend no more than $150 to buy a down-side hedge via a long put spread, 
and the bid/ask of the 102 put was $350/$400 and the 101 put was $200/
$250, the premium cost to the investor would be $200 (simultaneous 
purchase of the 102 put for $400 and

[[Page 51093]]

sale of the 101 put for $200). However, if the proposed $0.01 intervals 
were effective, and an investor wanted to spend no more than $150 to 
buy a down-side hedge via a long put spread, and the bid/ask of the 102 
put was $359/$360 and of the 101 put was $220/$221, the premium cost 
would be $140 (simultaneous purchase of the 102 put for $360 and sale 
of the 101 put for $220). This would garner the investor as much as a 
$60 or 30% savings in the cost to put on the desired hedge. The 
proposed interval range would clearly be very advantageous to 
investors; and would be costly if not available.\45\
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    \45\ The Exchange notes that in that Treasury security option 
positions could be quite large because the underlying instruments 
would be in $10,000 denominations, the percentage savings discussed 
in the examples could be very significant.
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    Proposed Rule 1014D sets forth that current Rule 1014 is applicable 
to Treasury securities options. Rule 1014 sets for obligations and 
restrictions applicable to specialists and ROTs and discusses, among 
other things, market making obligations, quoting obligations and 
parameters, and priority. Proposed Rule 1014D also sets forth that Rule 
1080 is applicable to Treasury securities options. Rule 1080 discusses 
the operation of Phlx XL and XL II, which are the Exchange's electronic 
platform in respect of orders, execution and trades. The Exchange 
specifically notes Rules 1014 and 1080 in proposed Rule 1014D because 
of the applicability to Treasury securities options trading of 
fundament trading-related matters in Rules 1014 and 1080 such as, for 
example, market making and quoting obligations, priority, and 
electronic trading.
    The Exchange likewise proposes Rule 1019D regarding maximum bids 
and offers that may be maintained by specialists and ROTs in options on 
Treasury securities. This rule states that without limiting the general 
obligation to deal for his account as stated in Rule 1014,\46\ a 
specialist or ROT holding an appointment in Treasury securities options 
is expected, in the course of maintaining a fair and orderly market, to 
bid and/or offer so as to create differences of:
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    \46\ Rule 1014 is, similarly to the relationship between current 
and proposed rules in the filing, supplemented by proposed Rule 
1019D. While bid/ask (offer) differentials are set forth for other 
(non-Treasury securities) options in Rule 1014, specific bid/ask 
(offer) differentials are set forth for Treasury securities options 
in proposed Rule 1014D. This is in line with the principle that 
while current options trading rules (e.g. 1014 and 1080) are 
applicable to Treasury securities options, certain rules 
specifically tailored to Treasury securities options trading are 
promulgated in this proposal.
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    (1) No more than $0.25 between the bid and offer for each option 
contract for which the bid is less than $1;
    (2) no more than $0.50 where the bid is $1 or more but less than 
$5;
    (3) no more than $0.80 where the bid is $5 or more but less than 
$10; and
    (4) no more than $1 where the bid is $10 or more.\47\
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    \47\ This is similar to the structure for maximum bids and 
offers for equity, index, and FCO (WCO) options on the Exchange. See 
Rule 1014(c).
---------------------------------------------------------------------------

    Subsection (b) of Rule 1019D states that for all longer term series 
the maximum bid/ask differentials are double those listed in subsection 
(a). This subsection states further that the differentials apply only 
to the two nearest term series of each class of Treasury security 
options. The Exchange notes that the proposed increments and maximum 
bid/ask variations are designed to allow the Exchange flexibility to 
list options with strike increments at appropriate levels, while 
diminishing any potential adverse effect on the Exchange's quote 
capacity thresholds. The Exchange believes that the operational 
capacity used to accommodate the trading of Treasury securities options 
on the Exchange will have a negligible effect on the total capacity 
used by the Exchange to trade its products on a daily basis.
Expiration and Exercise
    Proposed Rule 1008D discusses expiration and exercise price in 
respect of Treasury securities options. Subsection (a) states that a 
single Treasury security option covers $10,000 principal amount of the 
underlying security. The expiration month and exercise price of 
Treasury security options of each series shall be determined by the 
Exchange at the time each series of options is first opened for 
trading.\48\
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    \48\ When opening a Treasury security option for trading, the 
Exchange will open at least one series and one month. Proposed Rule 
1009D(a). The Exchange may open Treasury options within the 
``opening time frame,'' see proposed Rule 1006D(a)(2), which 
coincides with the on-the-run period for the underlying Treasury 
security. The Exchange has the ability to open and add Treasury 
options in one or all of the months in the opening timeframe. See 
also supra notes 36 and 37 and related text.
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    Subsection (b) provides that Treasury security options opened for 
trading on the Exchange will expire on a monthly basis, none further 
out than the options listing timeframe and additional series as defined 
in Rule 1006D.\49\ Subsection (c) provides that Treasury security 
options may be exercised only on the day that they expire. The 
subsection provides further that the exercise price of each series of 
Treasury security options shall be fixed at a price denominated in 
$0.50. In the case of a specific cusip Treasury security option, the 
exercise price will be reasonably close to, and no more than 20% away 
from, the price at which the underlying security is traded in the 
primary market at the time the series of options is first opened for 
trading.\50\ The proposed rule also states that the exercise price of 
additional series will be fixed at a multiple of $0.50.\51\
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    \49\ But cf. CBOE Rule 21.8(b), which allows the CBOE board (or 
a designee of the board) to provide alternate expiration cycles 
after notifying traders of Treasury security options.
    \50\ The Exchange believes that in light of the potential 
volatility in bond prices, the proposed 20% exercise price band 
around the underlying is quite reasonable. See, e.g., Commentary .06 
to Rule 1012 establishing a 20% volatility band (20% above and 20% 
below) for currency options (FCOs or WCOs).
    \51\ The Exchange notes that relatively small portions of a 
dollar, such as for example a quarter or less, may have a 
significant effect on exercise prices of positions held by traders 
and public customers because of the large size of the underlying 
Treasury securities options. The Exchange notes further that futures 
on similar Government securities, with which the proposed Treasury 
securities options would compete, enjoy intervals that are as small 
as one sixty-fourth of a point (dollar).
     To minimize the proliferation of strikes, however, the Exchange 
is proposing somewhat larger $0.50 intervals for Treasury securities 
option exercise strike prices.
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    Proposed Rule 1020D discusses exercise assignment notices in the 
case of Treasury securities options. Subsection (a) states that the 
method of allocation of exercise notices established pursuant to Rule 
1043 may provide that an exercise notice of block size \52\ shall be 
allocated to a customer or customers having an open short position of 
block size; and that an exercise notice of less than block size shall 
not be allocated, to the extent feasible, to a customer having a short 
position of block size. In the case of call option contracts, 
subsection (b) states that a member organization shall allocate an 
exercise notice to a customer who has made a specific deposit of the 
underlying security if it is directed to do so by the OCC.
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    \52\ For the purposes of this Rule, an exercise notice or a 
short position in a series of options where the total principal 
amount is $1 million or more and where the underlying security is a 
Treasury security shall be deemed to be of ``block size.'' 
Subsection (c) of Rule 1020D.
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Settlement and Delivery/Payment
    Options on Treasury securities will be physically settled and, 
being European style options, may be exercised only on the expiration 
date. The settlement process for Treasury securities options will be 
the same as the settlement process for equity options under current 
Exchange rules (e.g. Rule 1044).

[[Page 51094]]

    Subsection (a) to proposed Rule 1021D states, in respect of 
delivery and payment of options on Treasury securities, that payment of 
the aggregate exercise price in the case of specific cusip options must 
be accompanied by payment of accrued interest on the underlying 
Treasury security. The interest will be from (but not including) the 
last interest payment date to (and including) the exercise settlement 
date as specified in the rules of the OCC.
Position Limits
    In determining position limit compliance, proposed Rule 1002D 
establishes initial and maintenance position limits unique to options 
on Treasury securities.
    Regarding initial position limits, subsection (a) of proposed Rule 
1002D provides that the options shall be subject to a contract 
limitation (whether long or short) of the put type and the call type on 
the same side of the market covering a value no greater than 7.5% of 
the value of the initial or reopened public issuance, rounded to the 
next lower $100 million interval. For purposes of this position limit, 
there will be a combining of long positions in put options with short 
positions in call options, and short positions in put options with long 
positions in call options; or such other lower amount of options as 
fixed from time to time by the Exchange as the position limit for one 
or more classes or series of options. Subsection (a)(1) provides that 
in no event shall the position limit exceed a position on either side 
of the market covering a value in excess of $750,000,000 of the 
underlying securities. Subsection (a)(2) requires that the Exchange 
provide reasonable notice of each new position limit fixed by the 
Exchange, by notifying members thereof via OTA.
    To calculate the proposed $750,000,000 position limit proposed in 
Rule 1002D, the Exchange is using Position Accountability Levels 
(``Accountability Levels'' or ``limits'') for Treasury futures and 
options on such futures on CBOT as the starting basis. Unlike the 
current situation on options markets, where there is no active trading 
of Treasury derivatives, CBOT has the most active markets in the U.S. 
for trading listed futures on Treasuries and options on such futures. 
The current CBOT Accountability levels, which effectively serve as 
position limits on CBOT Treasury derivatives,\53\ are the equivalent of 
dollar position limits with a notional value of $2,500,000,000 for 
options on futures and $1,000,000,000 for futures on Treasury bonds 
traded on CBOT; and $2,000,000,000 for options on futures and 
$750,000,000 for futures on Treasury notes traded on CBOT.\54\ The 
Exchange is using these notional position limit values as a starting 
point to which it applies a conservative methodology to arrive at a 
proposed $750,000,000 proposed position limit in Rule 1002D for options 
on Treasury securities traded on the Exchange. First, the Exchange is 
using the CBOT futures Accountability limit for Treasury bonds 
(notional value of $1,000,000,000) to establish the proposed position 
limit for options on Treasury securities. This is because CBOT futures 
on Treasuries, rather than CBOT options on such futures, are arguably 
more similar to Exchange options on Treasury securities.\55\ Second, 
the Exchange is then applying a 25% haircut to the $1,000,000,000 
notional value for CBOT Treasury futures. This is because Exchange 
options on Treasury securities would settle into a single cusip 
Treasury security while CBOT Treasury futures and options settle into 
the cheapest to deliver Treasury security. And third, when compared to 
CBOT Treasury options on notes the proposed $750,000,000 position limit 
for Exchange options on Treasury securities is more that 60% lower that 
the position limit for CBOT Treasury options on futures (notional value 
of $2,000,000,000).\56\
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    \53\ See http://www.cmegroup.com/rulebook/files/CBOTChapter5_InterpretationClean.pdf.
    \54\ The dollar equivalent position limit value for options on 
Treasury bonds traded on CBOT, as an example, is calculated as 
follows: 25,000 share CBOT Accountability Level x CBOT Treasury 
option face value of $100,000 x Phlx option on Treasury security 
face value of $10,000 = $2,500,000,000.
    \55\ CBOE Treasury futures will, like Exchange options on 
Treasury securities, settle into the underlying Treasury notes or 
bonds; CBOT options on Treasury futures, on the other hand, will 
settle into the underlying derivative instruments (futures).
    \56\ The proposed $750,000,000 position limit for Exchange 
options on Treasury securities approximates the notional position 
limit for CBOT Treasury futures on notes.
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    The Exchange believes that its very conservative proposed nominal 
dollar position limit, in conjunction with the proposed equally 
conservative 7.5% of the value of the initial or reopened public 
issuance,\57\ will minimize (negate) potential manipulation and 
fraudulent activity in Treasury options.\58\
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    \57\ Upon examining U.S. Treasury record setting auction data at 
http://www.treasurydirect.gov/instit/annceresult/auctdata/auctdata_statdata.htm, which has ``Highest Offering Size'' for Treasury bonds 
and notes, the Exchange believes that the proposed 7.5% limit is 
quite conservative. For example, if the 7.5% maximum were applied to 
the ``Highest Offering Size'' for the 30 Year Treasury Bonds, which 
was $16,000,000,000 on November 12, 2009 (and was $44,000,000,000 
for 2-year Treasury notes), the maximum value would be 
$1,200,000,000. By establishing the proposed, substantially lower 
position limit of 7.5% and $750,000,000, the Exchange has put into 
place a mechanism that guards against achieving higher automatic 
positions limits in all Treasury bonds and notes, including the 
higher offering size 2-year Treasury notes.
    \58\ The Exchange also notes that its proposed position limits 
are significantly smaller that the position limits that were 
approved by the Commission decades ago for trading Treasury options 
on CBOE. See CBOE Rule 21.3(a), which states, in relevant part that: 
* * * Options on a Treasury security shall be subject to a contract 
limitation (whether long or short) of the put type and the call type 
on the same side of the market covering a value no greater than 10% 
of the value of the initial or reopened public issuance, rounded to 
the next lower $100 million interval * * * In no event shall the 
position limit exceed a position on either side of the market 
covering a value in excess of $1,200,000,000 of the underlying 
securities.
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    Regarding maintenance of position limits for Treasury securities 
options, subsection (b) of proposed Rule 1002D provides that in the 
event that any of the underlying Treasury securities are reported as 
``separate trading of registered interest and principal of securities'' 
(``strips'') in the Monthly Statement of the Public Debt of the United 
States Government, or such other report or compilation as may be 
selected from time to time by the Exchange, such stripping shall be 
taken into account in determining whether the position limit as 
initially established under paragraph (a) (``the established position 
limit'') can be maintained (the remaining non-stripped underlying 
securities are hereinafter referred to as ``the non-stripped 
securities'').
    Subsection (b)(1) states that the established position limit may 
remain so long as the position limit covers a principal amount of 
underlying securities not in excess of 7.5% of the non-stripped 
securities. However, in the event that the established position limit 
covers a principal amount of securities in excess of 7.5% of the non-
stripped securities, the Exchange shall reestablish the position limit 
to cover a principal amount of underlying securities not in excess of 
7.5% of the non-stripped securities.\59\ Subsection (2) provides that 
except as otherwise exempted under Exchange rules, persons whose 
positions exceed revised position limits may only engage in liquidating 
transactions until their positions are lower than the revised position 
limits.
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    \59\ Such revisions will become effective the Monday following 
the provision of notice thereof via OTA.
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    By virtue of proposed Rule 1003D, exercise limits for options on 
Treasury securities are equivalent to position limits on these 
instruments. This is similar to the relationship of position

[[Page 51095]]

and exercise limits for equity and other options pursuant to current 
Exchange rules.\60\
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    \60\ See Rules 1001 and 1002 (equity, ETF, currency options) and 
Rules 1001A and 1002A (index options).
---------------------------------------------------------------------------

    Moreover, proposed Rule 1004D states that for purposes of Rules 
1003 and 1004,\61\ references to Rule 1001 in connection with position 
limits shall be deemed, in the case of Treasury securities options, to 
be to Rule 1002D. The proposed rule states further that the reference 
in Rule 1003(a) to reports required of positions of 200 or more options 
shall, in the case of Treasury securities options, be revised to 
positions of options covering $2 million or more principal amount of 
underlying Treasury securities, for example, the 3.125% bonds due in 
the year 2042.
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    \61\ Rule 1003 deals with reporting of options positions and 
Rule 1004 deals with liquidation of options positions.
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Margin
    The current procedure for establishing margin on the Exchange is in 
Rule 721. The rule states that member organizations must elect whether 
they will follow CBOE or New York Stock Exchange (``NYSE'') margin 
rules, notify the Exchange of the election, and comply with the 
applicable rules.\62\ The Exchange proposes to amend Rule 721(b) to 
state that upon the filing of such election, a member organization 
engaged in trading Treasury securities options on the Exchange shall, 
in respect of such trading, comply with the NYSE initial and 
maintenance margin rules or CBOE margin rules in Chapter XII (not CBOE 
Government security options margin rules in Chapter XXI).\63\ Chapter 
XXI is specifically excluded to underscore that Exchange members must 
use CBOE option margin rules located in Chapter XII (or must use NYSE 
initial and maintenance margin rules). Proposed Rule 721(b) provides, 
however, that short Treasury securities options traded on the Exchange 
shall follow the margin percentage requirements for short equity 
options in NYSE margin rules or the margin percentage requirements for 
short equity options in CBOE Chapter XII; and that portfolio margin 
shall not be applicable to Treasury securities options.\64\
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    \62\ See Rule 721(b). Moreover, the rules states that the 
election shall be promptly made in writing by a notice filed with 
the Exchange; and that each member organization shall be bound to 
comply with the margin rules of CBOE or NYSE, as applicable, as 
though said rules were part of the Exchange's Margin Rules.
    \63\ CBOE Chapter XXI, which is not be used for Treasury 
securities options, contains rules for Government securities options 
including margin requirements in Rule 21.25.
     NYSE initial and maintenance margin requirements are generally 
in NYSE Rule 431.
    \64\ For general information regarding portfolio margin, see 
http://www.investopedia.com/terms/p/portfolio-margin.asp#axzz21e62XlUP.
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    Proposed Rule 1022D states that Exchange member organizations shall 
comply with initial and maintenance margin requirements per Rule 721. 
By operation of proposed Rule 1022D, member organizations involved in 
trading Treasury security options will be bound by CBOE or NYSE options 
margin rules consistent with member organizations' choices of CBOE or 
NYSE for other margin purposes.
    The Exchange believes that this proposed margin procedure is 
particularly appropriate for Treasury securities options. First, it 
ensures consistency in that member organizations must consistently 
follow the margin rules of either CBOE or NYSE according to their 
written margin rules election per Rule 721; and in particular must 
follow the short equity margin percentage requirements of CBOE or NYSE. 
Second, it is operationally and systemically efficient in that member 
organizations can immediately apply the relevant margin procedures that 
they use for options margin (e.g. short equity margin percentages) to 
the proposed new Treasury securities options; and the Exchange can use 
established margin surveillance processes, thereby reducing the 
potential for error from all perspectives. And third, the current 
option margin rules of CBOE are, without a doubt, more up to date and 
usable in today's fast-paced hybrid and electronic trading environment 
than the decades-old CBOE Government securities options margin rules.
    When trading short Treasury securities options, member 
organizations must, per proposed Rule 721, apply NYSE or CBOE short 
equity margin rules. Thus, in terms of CBOE margin rules, CBOE Rule 
12.3 (which contains a 20% short margin requirement) would be 
applicable to equity options margin as well as to Treasury securities 
margin. As an example, when applying the 20% short margin requirement 
to one short at-the-money equity option call contract priced at $3.00 
on XYZ stock priced at $100.00, the margin would be $2,300. This amount 
is calculated by adding 100% of options proceeds received (one call 
option contract priced at $3.00 equals $300) plus 20% of the underlying 
security value (the underlying security value of 100 shares of XYZ 
stock priced at $100.00 equals $10,000). And, when applying the 20% 
short margin requirement to one short at-the-money Treasury securities 
option call contract priced at $3.00 on an on-the-run 30 year Treasury 
bond priced at $100.00, the margin would be $2,300. This amount is 
calculated by adding 100% of options proceeds received (one call option 
contract priced at $3.00 equals $300) plus 20% of the underlying 
security value (the underlying principal value of a single option on-
the-run 30 year Treasury bond equals $10,000). The Exchange believes 
that the short Treasury security option margin methodology proposed 
reflects a proper, and indeed very safe, margin requirement.\65\
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    \65\ Moreover, the Exchange believes that the relationship of 
the underlying principal (in terms of Treasury securities options) 
compared to the equivalent amount of underlying shares (in terms of 
equity options) is appropriate. For example, 100 shares of XYZ stock 
priced at $100 equals $10,000, which is the same amount as a single 
on-the-run Treasury security option covering a $10,000 principal 
amount of the underlying Treasury security.
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Doing Business With the Public
    Proposed rule 1025D sets up guidelines dealing with customer 
account approval and supervisory qualification. Subsection (a) states 
that approval of the accounts of customers shall be conducted in 
accordance with Rule 747 \66\ and, in the case of institutional options 
customers (i.e., customers that are not natural persons), a member 
organization shall seek to obtain the following information:
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    \66\ Rule 747, which is applicable to all Exchange member 
organizations, among other things indicates that prior to making any 
brokerage transaction for the account of a customer, the opening of 
a customer account must have been properly approved.
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    (1) Evidence of authority for the institution to engage in Treasury 
securities options transactions (corporate resolutions, trust 
documents, etc.);
    (2) Written designation of individuals within the institution 
authorized to act for it in connection with Treasury securities options 
transactions; and
    (3) Basic financial information concerning the institution.
    Subsection (b) states that as a general matter, supervisory 
qualifications of a Registered Options Principal may be demonstrated 
only by successful completion of an examination prescribed by the 
Exchange (e.g. Series 4) for the purpose of demonstrating an adequate 
knowledge of Treasury securities options and the underlying Treasury 
securities.\67\ Subsection (c)

[[Page 51096]]

states that the conduct of Treasury securities option business at a 
branch office of a member organization may be supervised by any 
Registered Options Principal of the member organization. Subsection (d) 
states that any sales personnel of a member organization who solicit or 
accept customer orders with regard to options on Treasury securities 
shall be deemed qualified with regard to such options after such 
personnel successfully completed an examination prescribed by the 
Exchange for the purpose of demonstrating adequate knowledge of options 
and the underlying Treasury securities.
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    \67\ In exceptional circumstances and where good cause is shown, 
however, the Exchange may, upon written request by a member 
organization, accept as a demonstration of equivalent knowledge 
other evidence of a Registered Options Principal's supervisory 
qualifications.
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Other Trading-Related Rules
    The Exchange proposes additional trading-related rules for Treasury 
securities options that are similar to certain rules that are 
applicable to equity and other options. Proposed Rule 1018D states that 
a limit order book will be available for Treasury securities options. 
Proposed Rule 1015D states that accommodation trading under the 
applicable terms and conditions of Rule 1059 will be available in each 
series of Treasury securities option contracts open for trading on the 
Exchange. However, bids or offers for opening transactions at a price 
of $1 per option contract may be executed only with closing 
transactions that cannot at that time in open outcry be executed with 
another closing transaction. Proposed Rule 1016D states that all 
members, member firms, and clearing members shall resolve unmatched 
trades in Treasury security options from the previous day's trading no 
later than 9:00 a.m. (Eastern Time) of the following business day. And 
proposed Rule 1024D permits members to establish and maintain 
communication links with other members for the purpose of obtaining 
timely information on price movements in Treasury securities on which 
options are dealt in on the Exchange.
    Proposed Rule 1023D sets forth procedures regarding furnishing of 
books, records, and other information to the Exchange. Subsection (a) 
provides that no specialists or ROTs in Treasury securities options 
shall fail to make available to the Exchange books, records or other 
information \68\ as may be called for under the rules or as may be 
requested in the course of any investigation, any inspection or other 
official inquiry by the Exchange. In addition, the provisions governing 
identification of accounts and reports of orders shall, in the case of 
specialist or ROTs in Treasury securities options, apply to (i) 
accounts for Treasury securities deliverable under the terms of the 
option contracts involved, Treasury securities futures, options on 
Treasury securities futures and Treasury securities options trading; 
and (ii) orders entered by the specialist or ROT for the purchase or 
sale of Treasury securities deliverable under the terms of the options 
contracts involved, Treasury securities futures, options on Treasury 
securities futures, options on Treasury securities and opening and 
closing positions therein. Also, subsection (b) states that any 
corporate affiliate of a specialist or ROT in Treasury securities 
options shall maintain and preserve such books, records or other 
information as may be necessary to comply with this rule.
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    \68\ More specifically, such books, records, or information as 
maintained by or in the possession of such member or any corporate 
affiliate of such member pertaining to transactions by such member 
or any such affiliate for its own account in Treasury securities, 
Treasury securities futures or in Treasury securities options.
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    Proposed Rules 1011D and 1012D state that Rules 1047 and 1092 are 
applicable to Treasury securities options. Rule 1047 governs trading 
halts, rotations and suspensions, and Rule 1092 governs obvious errors 
and catastrophic errors for equity (and other) options traded on the 
Exchange. Proposed Rule 1012D(a) states that in addition to the factors 
set forth in Rule 1047, a factor that may be considered by Options 
Exchange Officials in connection with the institution of trading halts 
is that current quotations for the underlying Treasury securities are 
unavailable or have become unreliable; or that there is a need to 
prevent an unfair and disorderly market.\69\
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    \69\ For example, where the underlying Treasuries are still 
trading, there may be a severe anomaly in the Treasury options 
market caused by, for example, by an extreme price move in the 
equities market which triggers a circuit breaker and halts equity 
and other trading for a period of time.
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    Proposed Rule 1012D(b) states that Rule 1092 error procedures shall 
be applicable to Treasury securities options. The Exchange proposes to 
amend Rule 1092(a) to state, for purposes of conformity, that Treasury 
security options will have the same obvious error thresholds as equity 
and index options.\70\
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    \70\ The proposed new language in Rule 1092(a) will add, 
regarding Treasury securities options, that for purposes of the rule 
an Obvious Error will be deemed to have occurred when the execution 
price of a transaction is higher or lower than the Theoretical Price 
for a series by an amount equal to at least the amount shown in the 
table above.

                     For Treasury Securities Options
------------------------------------------------------------------------
                                                               Minimum
                     Theoretical price                          amount
------------------------------------------------------------------------
Below $2...................................................         $.25
$2 to $5...................................................          .40
Above $5 to $10............................................          .50
Above $10 to $20...........................................          .80
Above $20..................................................         1.00
------------------------------------------------------------------------

The Exchange believes that the proposed obvious error threshold, being 
similar to equity and index options thresholds, will promote 
consistency and predictability for traders; and that the thresholds are 
proper in light of the expected trading Treasury options trading 
ranges.\71\ The Exchange also proposes to amend Rule 1092(c)(iv)(D) to 
state that, similarly to equity options, treasury security option 
trades on the Exchange will be nullified when the trade occurred during 
a trading halt of the underlying Treasury security instituted by the 
United States Government. Unlike other exchange-traded options products 
that have a primary market for the underlying security (for example, 
equity options and index options), there is no similar primary market 
for underlying Treasury securities that are traded over the counter. As 
such, a Treasury security options trading halt would be based on a 
trading halt of the underlying Treasury security instituted by the 
United States Government.\72\
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    \71\ Moreover, the Exchange notes that as with any new product, 
the Exchange will adjust the Treasury options obvious error rule 
based on experiential need.
    \72\ As discussed, a Treasury securities option trading halt may 
also be instituted to prevent an unfair and disorderly market.
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Surveillance
    The Exchange will implement surveillance systems that are being 
used for equity, ETF, currency, and index options to monitor trading in 
Treasury securities options. This will include, but not be limited to, 
monitoring for insider trading, manipulation, front-running, and 
capping and pegging. The Exchange will also monitor public media for 
rating downgrades and other relevant actions to ensure that the 
Exchange's maintenance standards are fulfilled, and will monitor for 
any material actions that may influence the pricing of Treasury 
securities and options thereon.
2. Statutory Basis
    The Exchange believes that its proposal is consistent with Section 
6(b) of the Act \73\ in general, and furthers the objectives of Section 
6(b)(5) of the Act \74\

[[Page 51097]]

in particular, in that it is 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, by implementing new rules 
allowing the Exchange to list options on Treasury debt securities and 
allow trading thereon.
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    \73\ 15 U.S.C. 78f(b).
    \74\ 15 U.S.C. 78f(b)(5).
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    The Exchange believes that the proposed rules for listing and 
trading Treasury securities options, including options on Treasury 
notes and bonds, are reasonable and consistent with the Act. The 
Exchange believes that its proposal would enhance competition and 
provide access to an additional trading and investing vehicle so that 
traders and large, institutional, retail, and public investors could 
more effectively and closely tailor their investing and hedging 
decisions.
    The Exchange has proposed rules that are specifically tailored for 
trading Treasury security options. Pursuant to these proposed rules, 
the underlying Treasury securities may be approved as appropriate for 
listing options subject to requirements as to size of original 
issuance, aggregate principal amount outstanding, or years to maturity. 
The proposed position limits, exercise limits, margin rules, and other 
rules, in conjunction with the current Exchange rules, are particularly 
tailored for Treasury securities options, reasonable, and consistent 
with the Act. In particular, the proposed position and exercise limits 
reasonably balance the promotion of a free and open market for these 
securities with minimization of incentives for market manipulation and 
insider trading; and the proposed margin rules are reasonably designed 
to deter a member or its customer from assuming an imprudent position 
in Treasury securities options.
    For these and previously-noted reasons, the Exchange believes that 
the proposal to allow the Exchange to list and permit trading of 
Treasury securities options would enhance competition and provide 
access to valuable additional trading and investing vehicles. These 
would allow traders and investors--including large and institutional 
investors and retail and public investors--to more effectively tailor 
their investing and hedging decisions in the current challenging 
economic climate.

B. Self-Regulatory Organization's Statement on Burden on Competition

    Phlx does not believe that the proposed rule change will impose any 
burden on competition not necessary or appropriate in furtherance of 
the purposes of the Act. To the contrary, the Exchange believes that 
its proposal is pro-competitive. The proposal will allow a new and 
innovative options product to be listed and traded on the Exchange. 
This will give market participants the ability to significantly expand 
their trading and hedging capabilities.

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

    Within 45 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the Exchange consents, the Commission shall: (a) By order approve 
or disapprove such proposed rule change, or (b) institute proceedings 
to determine whether the proposed rule change should be disapproved.

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 email to rule-comments@sec.gov. Please include 
File Number SR-Phlx-2012-105 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-Phlx-2012-105. This file 
number should be included on the subject line if email 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 Web site 
viewing and printing in the Commission's Public Reference Room on 
official business days between the hours of 10:00 a.m. and 3:00 p.m. 
Copies of such filing also will be available for inspection and copying 
at the principal offices 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 submissions 
should refer to File Number SR-Phlx-2012-105, and should be submitted 
on or before September 13, 2012.
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    \75\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\75\
Elizabeth M. Murphy,
Secretary.
[FR Doc. 2012-20714 Filed 8-22-12; 8:45 am]
BILLING CODE 8011-01-P


