
[Federal Register Volume 83, Number 247 (Thursday, December 27, 2018)]
[Notices]
[Pages 66779-66782]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2018-27992]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-84870; File No. SR-NYSEAMER-2018-39]


Self-Regulatory Organizations; NYSE American LLC; Order 
Instituting Proceedings To Determine Whether To Approve or Disapprove a 
Proposed Rule Change To Allow Flexible Exchange Equity Options Where 
the Underlying Security Is an Exchange-Traded Fund That Is Included in 
the Option Penny Pilot To Be Settled in Cash

December 19, 2018.

I. Introduction

    On September 20, 2018, NYSE American LLC (``NYSE American'' or the 
``Exchange'') filed with the Securities and Exchange Commission 
(``Commission''), pursuant to Section 19(b)(1) of the Securities 
Exchange Act

[[Page 66780]]

of 1934 (``Act'') \1\ and Rule 19b-4 thereunder,\2\ a proposed rule 
change to modify the rules related to Flexible Exchange (``FLEX'') 
Options to allow FLEX Equity Options where the underlying security is 
an Exchange-Traded Fund (``ETF'') that is included in the Option Penny 
Pilot to be settled in cash.\3\ The proposed rule change was published 
for comment in the Federal Register on October 11, 2018.\4\ On November 
19, 2018, pursuant to Section 19(b(2) of the Act,\5\ the Commission 
designated a longer period within which to either approve the proposed 
rule change, disapprove the proposed rule change, or institute 
proceedings to determine whether to disapprove the proposed rule 
change.\6\ The Commission received one comment on the proposed rule 
change.\7\ This order institutes proceedings under Section 19(b)(2)(B) 
of the Act\8\ to determine whether to approve or disapprove the 
proposed rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ For the definitions of ``FLEX Options,'' ``FLEX Equity 
Options,'' and ``Option Penny Pilot,'' see infra notes 9 and 11.
    \4\ See Securities Exchange Act Release No. 84364 (October 4, 
2018), 83 FR 51535 (October 11, 2018) (``Notice'').
    \5\ 15 U.S.C. 78s(b)(2).
    \6\ See Securities Exchange Act Release No. 82994 (April 4, 
2018), 83 FR 15441 (April 10, 2018). The Commission designated 
January 9, 2019, as the date by which it should approve, disapprove, 
or institute proceedings to determine whether to disapprove the 
proposed rule change.
    \7\ See Letter to Brent J. Fields, Secretary, Commission, from 
Samara Cohen, Head of ETF Global Markets, BlackRock, dated November 
27, 2018 (``BlackRock Letter'').
    \8\ 15 U.S.C. 78s(b)(2)(B).
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II. Description of the Proposal and Comments Received

    The Exchange has proposed to amend NYSE American Rule 903G(c) to 
allow for cash settlement for certain FLEX Equity Options.\9\ 
Currently, FLEX Equity Options settle by physical delivery of the 
underlying security.\10\ The Exchange proposes, in the case of a FLEX 
Equity Option whose underlying security is an ETF that is included in 
the Option Penny Pilot \11\ (``FLEX ETF Option''), to allow settlement 
either by the delivery of cash or, as currently permitted under the 
Exchange rules, by physical delivery of the underlying security.\12\
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    \9\ A ``FLEX Option'' is a customized options contract that is 
subject to the rules in Section 15, Flexible Exchange Options. See 
NYSE American Rule 900G(b)(1). A ``FLEX Equity Option'' is an option 
on a specified underlying equity security that is subject to the 
rules of Section 15. See NYSE American Rule 900G(b)(10).
    \10\ See NYSE American Rule 903G(c)(3)(i). There is an exception 
to physical settlement for settlement of FLEX Binary Return 
Derivatives (``ByRDs''). See NYSE American Rules 900G(b)(17), 
903G(c)(3)(ii), and 910ByRDs.
    \11\ The ``Option Penny Pilot'' is a pilot program by the 
options exchanges that permits certain option classes to be quoted 
in penny or nickel increments on a pilot basis. See NYSE American 
Rule 960NY, Commentary .02. See also Securities Exchange Act Release 
No. 55162 (January 24, 2007), 72 FR 4738, 4739 (February 1, 2007) 
(SR-Amex-2006-106) (``Option Penny Pilot Approval Order''). The 
Option Penny Pilot is currently set to expire on December 31, 2018. 
See NYSE American Rule 960NY, Commentary .02.
    \12\ See proposed NYSE American Rule 903G(c)(3)(ii). The 
Exchange proposes conforming changes to NYSE American Rule 
903G(c)(3) to reflect that the proposed rule change would add a 
second exception to the general requirement for physical settlement 
for FLEX Equity Options. See proposed NYSE American Rule 
903G(c)(3)(i) and (iii).
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    The Exchange states that it believes that it is appropriate to 
introduce cash settlement as an alternative for FLEX ETF Options 
because ETFs generally have increasingly become a major part of 
investors' portfolios, allowing investors to take advantage of many 
unique opportunities to hedge their portfolios and manage risk.\13\ The 
Exchange asserts that physical settlement possess certain risks with 
respect to volatility and movement of the underlying security at 
expiration that market participants may need to hedge against and cash 
settlement does not present these same risks.\14\
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    \13\ See Notice, supra note 4, at 51535-36.
    \14\ See id. at 51536. The Exchange also states that market 
participants trade cash-settled FLEX ETF Options in the over-the-
counter market and exchange trading would provide benefits to these 
market participants. See id.
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    The Exchange states that it seeks to allay concerns about cash-
settled equity options by proposing to adopt cash settlement as an 
alternative settlement method for 64 ETFs that are included in the 
Option Penny Pilot.\15\ The Exchange adds that generally index options 
are cash-settled and derive their value from a disseminated index 
price, and that similarly ETFs typically have their values linked to a 
disseminated index price.\16\ The Exchange states that the option 
classes included in the original pilot were chosen based on being one 
of the most actively-traded multiply-listed options classes and also 
states that the most recent expansion identified the most-active 
classes based on the ``underlying security's `national average daily 
volume over a six-month period.' '' \17\
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    \15\ See id.
    \16\ See id.
    \17\ See id. The Commission notes that the criteria for 
qualifying for the Option Penny Pilot is based on the national 
average daily volume over a six month period in the options class 
itself, not based on the volume of the underlying ETF. See 
Securities Exchange Act Release No. 60711 (September 23, 2009), 74 
FR 49419 (September 28, 2009) (SR-NYSEArca-2009-44) (``Option Penny 
Pilot Expansion Order'') and Securities Exchange Act Release No. 
61106 (December 3, 2009), 74 FR 65193 (December 9, 2009) (NYSEAmex-
2009-74) (Option Penny Pilot Expansion Notice'').
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    The Exchange states that cash-settled FLEX ETF Options would be 
subject to the same position limits as non-cash-settled FLEX ETF 
Options (i.e., the position limits in NYSE American Rule 906G).\18\ The 
Exchange represents that it confirmed with the Options Clearing 
Corporation (``OCC'') that OCC can support the clearance and settlement 
of cash-settled FLEX ETF Options.\19\ The Exchange also states that it 
believes the Exchange and the Options Price Reporting Authority 
(``OPRA'') have the necessary systems capacity to handle the additional 
traffic associated with the listing of cash-settled FLEX ETF Options 
and that it believes that its members will not have a capacity issue as 
a result of the proposal.\20\ The Exchange represents that it does not 
believe that the proposed rule change will cause fragmentation of 
liquidity.\21\ The Exchange further represents that it will monitor the 
trading volume associated with the options series listed as a result of 
this proposed rule change and the effect, if any, of these series on 
market fragmentation and on the capacity of the Exchange's automated 
systems.\22\
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    \18\ See Notice, supra note 4, at 51536. The Exchange adds that 
other existing regulatory safeguards, such as exercise limits and 
reporting requirements, would also continue to apply. See id. at 
51537. The Commission notes that NYSE American Rule 906G provides 
generally that there are no position limits for FLEX Equity Options, 
but that positions in FLEX Options that expire on a third Friday-of-
the-month expiration day (``Expiration Friday'') will be aggregated 
with positions in non-FLEX Options on the same underlying and 
subject to the position limits applicable to such options. See NYSE 
American Rule 906G(b).
    \19\ See Notice, supra note 4, at 51536.
    \20\ See id.
    \21\ See id.
    \22\ See id.
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    The Exchange represents that it will have an adequate surveillance 
program for cash-settled FLEX ETF Options and states that it intends to 
use the same surveillance procedures, including procedures concerning 
surveillance for manipulation, for cash-settled FLEX ETF Options that 
it uses for the Exchange's other options products.\23\ The Exchange 
states that it believes manipulating the settlement price of cash-
settled FLEX ETF Options would be difficult because of the size of the 
market for such ETFs.\24\ According to the Exchange each cash-settled 
FLEX ETF Option is sufficiently active so as to alleviate concerns 
about the potential

[[Page 66781]]

for manipulation.\25\ The Exchange states that the vast liquidity of 
ETF options and the underlying equities markets and the high level of 
participation among market participants that enter quotes or orders in 
ETF options would, according to the Exchange, make it very difficult 
for a single participant to alter the prices of each security 
underlying an ETF without becoming exposed to regulatory scrutiny and 
that such attempt at manipulation would be cost-prohibitive.\26\ 
Moreover, the Exchange states that it is a member of the Intermarket 
Surveillance Group (``ISG'') and therefore would have access to 
surveillance and investigative information regarding trading in the 
underlying securities.\27\
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    \23\ See id.
    \24\ See id.
    \25\ See id. at 51536-37.
    \26\ See id. at 51537.
    \27\ See id.
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    The Commission received one comment letter, which supports the 
proposed rule change.\28\ The commenter states that it agrees with the 
Exchange that the proposal alleviates several potential challenges 
associated with physical settlement and presents advantages to the end 
investor. This commenter asserts that the proposal would lead to 
greater standardization of contract terms, mitigate counterparty risk, 
increase price discovery, and improve information dissemination, which 
would lead to greater transparency.\29\
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    \28\ See BlackRock Letter, supra note 7.
    \29\ See id.
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III. Proceedings To Determine Whether To Approve or Disapprove SR-
NYSEAMER-2018-39 and Grounds for Disapproval Under Consideration

    The Commission is instituting proceedings pursuant to Section 
19(b)(2)(B) of the Act to determine whether the proposal should be 
approved or disapproved.\30\ Institution of such proceedings is 
appropriate at this time in view of the legal and policy issues raised 
by the proposed rule change, as discussed below. Institution of 
disapproval proceedings does not indicate that the Commission has 
reached any conclusions with respect to any of the issues involved.
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    \30\ 15 U.S.C. 78s(b)(2)(B).
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    Pursuant to Section 19(b)(2)(B) of the Act, the Commission is 
providing notice of the grounds for disapproval under consideration. 
The Commission is instituting proceedings to allow for additional 
analysis and input concerning the proposed rule change's consistency 
with the Act \31\ and, in particular, with Section 6(b)(5) of the Act, 
which requires, among other things, that the rules of a national 
securities exchange be designed to prevent fraudulent and manipulative 
acts and practices, 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.\32\
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    \31\ 15 U.S.C. 78f(b)(5).
    \32\ Id.
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    As discussed above, the Exchange proposes to modify NYSE American 
Rule 903G(c)(3)(ii) to allow cash settlement for FLEX ETF Options. In 
its proposal, the Exchange acknowledges that concerns have been raised 
in the past regarding the susceptibility of cash-settled equity options 
to manipulation. The Exchange asserts that to address such concerns, it 
has proposed to limit cash settlement to options on a narrow set of 
ETFs that are the most actively traded, as evidenced by the inclusion 
of options on those ETFs in the Option Penny Pilot.\33\ The Commission 
notes that the goal of the Option Penny Pilot since its inception has 
been to analyze the impact of penny quoting on options spreads, 
transaction costs, payment for order flow, and quote message 
traffic.\34\ As a result, the Option Penny Pilot eligibility criterion 
is based on the national average daily volume of the options classes 
rather than the volume in the underlying securities.
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    \33\ See Notice, supra note 4, at 51536.
    \34\ See Option Penny Pilot Approval Order, supra note 11, at 
4740. As noted in the 2009 Option Penny Pilot Expansion Order, for 
example, the pilot report provided information on the most active 
and least active options classes in the pilot and analyzed the 
impact the pilot had on those options in certain specified areas. 
See supra note 17, at 49420. See also Option Penny Pilot Expansion 
Notice, supra note 17, at 65194.
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    The Commission notes that critical to any assessment of the 
potential for manipulation when trading cash-settled options on ETFs is 
also an analysis of the liquidity and depth of the market for both the 
ETFs underlying the options and the component securities of the ETFs 
themselves. The Exchange has not, however, provided any specific data, 
analysis, and studies demonstrating that the ETFs underlying the 
options included in the Option Penny Pilot have the liquidity necessary 
to adequately address concerns on the risks of manipulation and 
potential for market disruption that may arise from cash settlement on 
such options.
    As noted above, because options in the Option Penny Pilot are 
assessed every six months based on options trading volume, we believe 
the 64 ETFs underlying the options in the Option Penny Pilot that the 
Exchange identifies generally in its proposal were those eligible for 
the pilot as of the date the Exchange submitted its proposal to the 
Commission. This raises further questions, which are not addressed in 
the current proposal, as to how the Exchange will treat options on 
those ETFs that become ineligible for the Option Penny Pilot in the 
future, as well as how to analyze the potential for manipulation and 
market disruption from future ETFs underlying options that are not yet, 
but later, included in the Option Penny Pilot and will therefore become 
eligible for cash settlement under the Exchange's proposal.
    The Exchange also takes the position that cash settlement for 
options is not unique because other options exchanges trade cash-
settled options.\35\ Cash-settled options on equity securities such as 
ETFs that hold specific component securities, however, are unique and 
present distinct issues different from cash-settled index options that 
track an index. The Commission notes that allowing for cash settlement 
of FLEX ETF Options, as proposed, would permit cash settlement on a 
significantly broader set of equity options than that previously 
approved. Further, it is not clear from the Exchange's proposal how the 
expanded use of cash settlement for equity options may bear on the 
potential for manipulation or impact market quality since, as noted 
above, the proposal lacks any supporting data or analysis on these 
issues.
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    \35\ See Notice, supra note 4, at 51536.
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    The Exchange proposes to apply the same position limits to cash-
settled FLEX ETF Options as for other FLEX Equity Options. The 
Commission notes that the Exchange generally does not impose position 
limits for FLEX Equity Options unless the FLEX Equity Options' 
expiration coincides with an Expiration Friday.\36\ This means that 
there would be no position limits, including on the days leading up to 
and surrounding Expiration Friday, for many of the cash-settled FLEX 
ETF Options under the proposal. The Commission is therefore concerned 
that the lack of position limits for non-Expiration Friday expiring 
cash-settled FLEX ETF Options could make them more susceptible to 
manipulation and could lead to market disruption.
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    \36\ See NYSE American Rule 906G(b).
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    Finally, the Commission notes that the proposal would allow for 
settlement in cash or by physical delivery on options that otherwise 
have the same terms. The Commission notes that allowing both physical 
delivery and cash settlement alternatives could

[[Page 66782]]

increase market fragmentation and raise additional manipulation 
concerns.
    The Commission notes that under the Commission's Rules of Practice, 
the ``burden to demonstrate that a proposed rule change is consistent 
with the Exchange Act and the rules and regulations issued thereunder . 
. . is on the self-regulatory organization [`SRO'] that proposed the 
rule change.'' \37\ The description of a proposed rule change, its 
purpose and operation, its effect, and a legal analysis of its 
consistency with applicable requirements must all be sufficiently 
detailed and specific to support an affirmative Commission finding,\38\ 
and any failure of an SRO to provide this information may result in the 
Commission not having a sufficient basis to make an affirmative finding 
that a proposed rule change is consistent with the Exchange Act and the 
applicable rules and regulations.\39\
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    \37\ Rule 700(b)(3), Commission Rules of Practice, 17 CFR 
201.700(b)(3).
    \38\ See id.
    \39\ See id.
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    For these reasons, the Commission believes it is appropriate to 
institute proceedings pursuant to Section 19(b)(2)(B) of the Act to 
determine whether the proposal should be approved or disapproved.

IV. Commission's Solicitation of Comments

    The Commission requests that interested persons provide written 
submissions of their views, data, and arguments with respect to the 
issues identified above, as well as any other concerns they may have 
with the proposal. In particular, the Commission invites the written 
view of interested persons concerning whether the proposal is 
consistent with Section 6(b)(5) or any other provision of the Act, or 
the rules and regulations thereunder. Although there do not appear to 
be any issues relevant to approval or disapproval that would be 
facilitated by an oral presentation of views, data, and arguments, the 
Commission will consider, pursuant to Rule 19b-4, any request for an 
opportunity to make an oral presentation.\40\
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    \40\ Section 19(b)(2) of the Exchange Act, as amended by the 
Securities Act Amendments of 1975, Public Law 94-29 (June 4, 1975), 
grants the Commission flexibility to determine what type of 
proceeding--either oral or notice and opportunity for written 
comments--is appropriate for consideration of a particular proposal 
by a self-regulatory organization. See Securities Act Amendments of 
1975, Senate Comm. on Banking, Housing & Urban Affairs, S. Rep. No. 
75, 94th Cong., 1st Sess. 30 (1975).
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    Interested persons are invited to submit written data, views, and 
arguments regarding whether the proposal should be approved or 
disapproved by January 17, 2019. Any person who wishes to file a 
rebuttal to any other person's submission must file that rebuttal by 
January 31, 2019. The Commission asks that commenters address the 
sufficiency of the Exchange's statements in support of the proposal 
which are set forth in the Notice,\41\ in addition to any other 
comments they may wish to submit about the proposed rule change.
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    \41\ See Notice, supra note 4.
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    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-NYSEAMER-2018-39 on the subject line.

Paper Comments

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

All submissions should refer to File Number SR-NYSEAMER-2018-39. 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 website (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 website viewing and printing in 
the Commission's Public Reference Room, 100 F Street NE, Washington, DC 
20549, 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 office of the Exchange. All comments 
received will be posted without change. Persons submitting comments are 
cautioned that we do not redact or edit personal identifying 
information from comment submissions. You should submit only 
information that you wish to make available publicly. All submissions 
should refer to File Number SR-NYSEAMER-2018-39 and should be submitted 
on or before January 17, 2019. Rebuttal comments should be submitted by 
January 31, 2019.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\42\
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    \42\ 17 CFR 200.30-3(a)(57).
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Brent J. Fields,
Secretary.
[FR Doc. 2018-27992 Filed 12-26-18; 8:45 am]
BILLING CODE 8011-01-P


