[Federal Register: December 18, 2009 (Volume 74, Number 242)]
[Notices]
[Page 67295-67300]
[DOCID:fr18de09-115]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-61138; File No. SR-NYSEArca-2009-112]

Self-Regulatory Organizations; Notice of Filing and Immediate
Effectiveness of Proposed Rule Change by NYSE Arca, Inc. To Add
Commentary .01 to Rule 6.47

December 10, 2009.
    Pursuant to Section 19(b)(1) \1\ of the Securities Exchange Act of
1934 (the ``Act'') \2\ and Rule 19b-4 thereunder,\3\ notice is hereby
given that, on December 7, 2009, NYSE Arca, Inc. (``NYSE Arca'' or the
``Exchange'') filed with the Securities and Exchange Commission (the
``Commission'') the proposed rule change as described in Items I and II
below, which Items have been prepared by the self-regulatory
organization. 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\ 15 U.S.C. 78a.
    \3\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change

    The Exchange proposes to add Commentary .01 to Rule 6.47 to allow
hedging stock, security future or futures contract positions to be
represented currently with option facilitations or solicitations in the
Trading Crowd (``tied hedge'' orders) based on a recently approved rule
change of the Chicago Board Options Exchange (``CBOE'').\4\ The text of
the proposed rule change is attached as Exhibit 5 to the 19b-4 form.
The text of the proposed rule change is available on the Exchange's Web
site at http://www.nyse.com, on the Commission's Web site at http://
www.sec.gov, at the Exchange's principal office and at the Commission's
Public Reference Room.
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    \4\ See Securities Exchange Act Release No. 60499 (August 13,
2009), 74 FR 42350 (August 21, 2009) (order approving SR-CBOE-2009-
007).
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II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the self-regulatory organization
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 those 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 parts of such statements.

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

1. Purpose
    The Exchange is proposing to add Commentary .01 to Rule 6.47 to
allow hedging stock, security future or futures contract positions to
be represented currently with option facilitations or solicitations in
the Trading Crowd (``tied hedge'' orders), based on a recently approved
rule change of the CBOE. Rule 6.47 generally sets forth the procedures
by which a floor broker may cross an order with a contra-side order.
Currently, transactions executed pursuant to Rule 6.47 are subject to
the restrictions of paragraph (b) of Rule 6.49, Solicited Transactions,
which prohibits trading based on knowledge of imminent undisclosed
solicited transactions (commonly referred to as ``anticipatory
hedging'').

Existing Anticipatory Hedge Rule

    By way of background, when Rule 6.49 was adopted in 2001, the
Exchange noted its belief that it is appropriate to permit solicitation
between potential buyers and sellers of options in advance of the time
they send actual orders to the trading crowd on the Exchange. The
Exchange also noted that, if the orders that comprise a solicited
transaction are not suitably exposed to the order

interaction process on the Trading Floor, the execution of such orders
would not be consistent with Exchange rules designed to promote order
interaction in an open-outcry auction.\5\ Solicited transactions by
definition entail negotiation, and if the orders that comprise a
solicited transaction are not adequately exposed to the floor auction,
the in-crowd market participants (e.g., Market-Makers in the trading
crowd) cannot have sufficient time to digest and react to those orders'
terms. The pre-negotiation inherent in the solicitation process thus
can enable the parties to a solicited transaction to preempt the crowd
to an execution at the pre-negotiated price. Thus, the Exchange notes,
Rule 6.49 was originally designed to preserve the right to solicit
orders in advance of submitting a proposed trade to the crowd, while at
the same time assuring that orders that are the subject of a
solicitation are exposed to the auction market in a meaningful way. In
addition to requiring disclosure of orders and clarifying the priority
principles applicable to solicited transactions,\6\ Rule 6.49 provides
that it is inconsistent with just and equitable principles of trade for
any OTP Holder, OTP Firm, or associated person, who has knowledge of
all the material terms of an originating order \7\ and a solicited
order (including a facilitation order) that matches the original
order's price, to enter an order to buy or sell an option of the same
class as any option that is the subject of the solicitation prior to
the time that the original order's terms are disclosed to the crowd or
the execution of the solicited transaction can no longer reasonably be
considered imminent. This prohibition extends to orders to buy or sell
the underlying security or any ``related instrument,'' as that term is
defined in the rule.\8\
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    \5\ For example, Rule 6.73, Manner of Bidding and Offering,
requires bids and offers to be made at the post by public outcry,
and Rule 6.47 imposes order exposure requirements on floor brokers
seeking to cross buy orders with sell orders.
    \6\ For example, the rule requires that the OTP Holder or OTP
Firm representing an original order that is the subject of a
solicitation to disclose the terms of the original order to the
crowd before the original order can be executed. This disclosure is
intended to eliminate the unfairness that can be associated with
pre-negotiated transactions among the parties to the solicitation
versus the in-crowd market participants, and would subject the order
that is the subject of the solicitation to full auction interaction
with other orders in the crowd. In addition, priority is accorded
depending on whether the original order is disclosed throughout the
solicitation period; whether the solicited order improves the best
bid or offer in the trading crowd; and whether the solicited order
matches the original order's limit. Rule 6.47(b) contains exceptions
to these priority provisions in instances where a crossing
participation entitlement is sought.
    \7\ An ``originating order'' is an order respecting an option
traded on the Exchange, including a spread, combination, straddle,
stock option, security-future-option or any other complex order. See
Rule 6.9.
    \8\ For purposes of Rule 6.49(b), an order to buy or sell a
``related instrument,'' means, ``in reference to an index option, an
order to buy or sell securities comprising ten percent or more of
the component securities in the index or an order to buy or sell a
futures contract on any economically equivalent index.''
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    When originally adopted in 2001, the Exchange believed that the
prohibition on anticipatory hedging was necessary to prevent OTP
Holders and OTP Firms and associated persons from using undisclosed
information about imminent solicited option transactions to trade the
relevant option or any closely related instrument in advance of persons
represented in the relevant options crowd. NYSE Arca believes the basic
principle remains true today, but changes in the marketplace have
caused the Exchange to re-evaluate the effectiveness and efficiency of
the existing rule's procedural requirements. The Exchange believes that
increased volatility in the markets, as well as the advent of penny
trading in underlying stocks and resultant decreased liquidity at the
top of each underlying market's displayed national best bid or offer,
it has become increasingly difficult for OTP Holders and OTP Firms to
assess the ultimate execution prices and the extent of available stock
to hedge related options facilitation/solicitation activities, and to
manage that market risk. This risk extends to simple and complex
orders, and to all market participants involved in the transaction
(whether upstairs or on-floor) because of the uncertainty of the extent
to which the market participant will participate in the transaction,
the amount of time associated with the auction process, and the
likelihood that the underlying stock prices in today's environment may
be difficult to assess and change before they are able to hedge. These
circumstances make it difficult to obtain a hedge, difficult to quote
orders and difficult to achieve executions, and can translate into less
liquidity in the form of smaller size and wider quote spreads, fewer
opportunities for price improvement, and the inefficient handling of
orders. Additionally, more and more trading activity appears to be
taking place away from the exchange-listed environment and in the over-
the-counter (``OTC'') market, which by its nature is not subject to the
same trade-through type risks present in the exchange environment.
Therefore, the Exchange is seeking to make its trading rules more
efficient not only to address the market risk and execution concerns,
but also to effectively compete with and attract volume from the OTC
market. What is more, Market-Makers' trading strategies have evolved.
Where as [sic] before Market-Makers tended to trade based on delta
risk,\9\ now market-making strategy is based more on volatility.\10\
The tied hedge transaction procedures (described below) are designed in
a way that is consistent with this shift toward a volatility trading
strategy, and makes it more desirable for Market-Makers to compete for
orders that are exposed through the solicitation process.
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    \9\ The price of an option is not completely dependent on supply
and demand, nor on the price of the underlying security. Market-
Makers price options are based on basic measures of risk as well.
One of these such measures, delta, is the rate of change in the
price of an option as it relates to changes in the price of the
underlying security, security future or futures contract. The delta
of an option is measured incrementally based on movement in the
price of the underlying security, security future or futures
contract. For example, if the price of an option increases or
decreases by $1.00 for each $1.00 increase or decrease in the price
of the underlying security, the option would have a delta of 100. If
the price of an option increases or decreases by $0.50 for each
$1.00 increase or decrease in the price of the underlying security,
the option would have a delta of 50.
    \10\ Volatility is a measure of the fluctuation in the
underlying security's market price. Market-Makers that trade based
on volatility have options positions that they hedge with the
underlying. Once hedged, the risk exposure to the Market-Maker is
realized volatility and implied volatility. Realized volatility is
the actual volatility in the underlying. Implied volatility is
determined by using option prices currently existing in the market
at the time rather than using historical data on the market price
changes of the underlying.
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Proposed Exception to Anticipatory Hedge Rule

    In order to address the concerns associated with increased
volatility and decreased liquidity and more effectively compete with
the OTC market, the Exchange is proposing to adopt a limited exception
to the anticipatory hedging restrictions that would permit the
representation of hedging stock positions in conjunction with option
orders, including complex orders, in the options trading crowd (a
``tied hedge'' transaction). The Exchange believes this limited
exception remains in keeping with the original design of Rule 6.49, but
sets forth a more practicable approach considering today's trading
environment that will provide the ability to hedge in a way that will
still encourage meaningful competition among upstairs and floor
brokers. Besides stock positions, the proposal would also permit
security futures positions to be used as a hedge. In addition, in the
case where the order is for options on indices, options on exchange-
traded funds (``ETF'') or a related instrument may be used as a

hedge. A ``related instrument'' would mean, in reference to an index
option, securities comprising ten percent or more of the component
securities in the index or a futures contract on any economically
equivalent index applicable to the option order. A ``related
instrument'' would mean, in reference to an ETF, a futures contract on
any economically equivalent index applicable to the ETF underlying the
option order.\11\
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    \11\ For example, a tied hedge order involving options on the
iShares Russell 2000 Index ETF might involve a hedge position in the
underlying ETF, security futures overlying the ETF, or futures
contracts overlying the Russell 2000 Index.
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    With a tied hedge transaction, Exchange OTP Holders and OTP Firms
would be permitted to first hedge an option order with the underlying
security, a security future or futures contract, as applicable, and
then forward the option order and the hedging position to an Exchange
floor broker with instructions to represent the option order together
with the hedging position to the options trading crowd. The in-crowd
market participants that chose to participate in the option transaction
must also participate in the hedging position. First, under the
proposal, the original option order must be in a class designated as
eligible for a tied hedge transaction as determined by the Exchange,
including FLEX Options classes.\12\ The original option order must also
be within designated tied hedge eligibility parameters, which would be
determined by the Exchange and would not be smaller than 500
contracts.\13\ The Exchange notes that the minimum order size would
apply to an individual originating order.\14\ Multiple originating
orders could not be aggregated to satisfy the requirement (though
multiple contra-side solicited orders could be aggregated to execute
against the originating order). The Exchange states that the primary
purpose of this provision is to limit use of the tied hedge procedures
to larger orders that might benefit from an OTP Holder or OTP Firms'
ability to execute a facilitating hedge. Assuming an option order meets
these eligibility parameters, the proposal also includes a number of
other conditions that must be satisfied.
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    \12\ FLEX Options provide investors with the ability to
customize basic option features including size, expiration date,
exercise style, and certain exercise prices.
    \13\ The designated classes and minimum order size applicable to
each class would be communicated to OTP Holders via Regulatory
Circular. For example, the Exchange could determine to make the tied
hedge transaction procedures available in options class XYZ for
orders of 1,000 contracts or more. Such a determination would be
announced via Regulatory Circular, which would include a cumulative
list of all classes and corresponding sizes for which the tied hedge
procedures are available.
    \14\ In determining whether an individual original order
satisfies the eligible order size requirement, the proposed Rule
text states that any Complex Order must contain one leg alone which
is for the eligible order size or greater.
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    Second, the proposal would require that, prior to entering tied
hedge orders on behalf of customers, the OTP Holder or OTP Firm must
deliver to the customer a one-time written notification informing the
customer that their order may be executed using the Exchange's tied
hedge procedures. Under the proposal, the written notification must
disclose the terms and conditions contained in the proposed rule and be
in a form approved by the Exchange. Given the minimum size requirement
of 500 contracts per order, the Exchange believes that use of the tied
hedges procedures will generally consist of orders for the accounts of
institutional or sophisticated, high net worth investors. The Exchange
therefore believes that a one-time notification delivered by the OTP
Holder or OTP Firm to the customer would be sufficient, and that an
order-by-order notification would be unnecessary and overly burdensome.
    Third, an OTP Holder or OTP Firm would be required to create an
electronic record that it is engaging in a tied hedge order in a form
and manner prescribed by the Exchange. The Exchange states that the
purpose of this provision is to create a record to ensure that hedging
trades would be appropriately associated with the related options order
and appropriately evaluated in the Exchange's surveillance program. The
Exchange believes that this requirement should enable the Exchange to
monitor for compliance with the requirements of the proposed rule, as
discussed below, by identifying the specific purchase or sell orders
relating to the hedging position.
    Fourth, the proposed rule would require that OTP Holders and OTP
Firms that have decided to engage in tied hedge orders for
representation in the trading crowd would have to ensure that the
hedging position associated with the tied hedge order is comprised of a
position that is designated as eligible for a tied hedge transaction.
Eligible hedging positions would be determined by the Exchange for each
eligible class and may include (i) the same underlying stock applicable
to the options order, (ii) a security future overlying the same stock
applicable to the option order, or (iii) in reference to an option on
an index or an ETF, a ``related instrument'' (as described above). For
example, for options overlying XYZ stock, the Exchange may determine to
designate the underlying XYZ stock or XYZ security futures or both as
eligible hedging positions.\15\
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    \15\ As with designated classes and minimum order size, the
eligible hedging positions applicable to each class would be
communicated to the OTP Holder via Regulatory Circular, which would
include a cumulative list of all classes and corresponding sizes for
which the tied hedge procedures are available. See note 13, supra.
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    The Exchange states that the purpose of this provision is to ensure
that the hedging position would be for the same stock, equivalent
security future or related instrument, as applicable, thus allowing
crowd participants who may be considering participation in a tied hedge
order to adequately evaluate the risk associated with the option as it
relates to the hedge. With stock positions in particular, the Exchange
notes that occasionally crowd participants hedge option positions with
stock that is related to the option, such as the stock of an issuer in
the same industry, but not the actual stock associated with the option.
Except as otherwise discussed above for index options, the proposed
rule change would not allow such a ``related'' hedging stock position,
but would require the hedging stock position to be the actual security
underlying the option.
    Fifth, the proposal would require that the entire hedging position
be brought without undue delay to the trading crowd. In considering
whether the hedging position is presented without ``undue delay,'' the
Exchange believes that OTP Holders and OTP Firms should continue to
have the same ability to shop an order in advance of presenting it to
the crowd and should be able to enhance that process through obtaining
a hedge. The Exchange also believes that, once a hedge is obtained, the
order should be brought to the crowd promptly in order to satisfy the
``undue delay'' requirement. In addition, the proposal would require
that the hedging position be announced to the Trading Crowd
concurrently with the options order, offered to the crowd in its
entirety, and offered at the execution price received by the OTP Holder
or OTP Firm introducing the order to any in-crowd market participant
who has established parity or priority for the related options. In-
crowd market participants that participate in the option transaction
must also participate in the hedging position on a proportionate
basis\16\ and would not be

permitted to prevent the option transaction from occurring by giving a
competing bid or offer for one component of the tied hedge order. The
Exchange states that the purpose of these requirements is to ensure
that the hedging position represented to the crowd would be a good
faith effort to provide in-crowd market participants with the same
opportunity as the OTP Holder or OTP Firm introducing the tied hedge
order to compete most effectively for the option order.
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    \16\ For example, if an in-crowd market participant's allocation
is 100 contracts out of a 500 contract option order (\1/5\), the
same in-crowed market participant would trade 10,000 shares of a
50,000 stock hedge position tied to that option order (\1/5\).
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    For example, if an OTP Holder introducing a tied stock hedge order
were to offer 1,000 XYZ option contracts to the crowd (overlying
100,000 shares of XYZ stock) and concurrently offer only 30,000 of
100,000 shares of the underlying stock that the OTP Holder obtained as
a hedge, crowd participants might only be willing or able to
participate in 300 of the option contracts offered if the hedging stock
position cannot be obtained at a price as favorable as the stock
hedging position offering price, if at all. The Exchange states that
the effect of this would be to place the crowd at a disadvantage
relative to the introducing OTP Holder for the remaining 700 option
contracts in the tied stock hedge order, and thus create a disincentive
for the crowd to bid or offer competitively for the remaining 700
option contracts. The Exchange believes the requirement that the
hedging position be presented concurrently with the option order in the
crowd and offered to the crowd in its entirety at the execution price
received by the OTP Holder or OTP Firm introducing the order should
ensure that the crowd would be competing on a level playing field with
the introducing OTP Holder or OTP Firm to provide the best price to the
customer.
    Sixth, the proposal would require that the hedging position not
exceed the options order on a delta basis. For example, in the
situation where a tied stock hedge order involves the simultaneous
purchase of 50,000 shares of XYZ stock and the sale of 500 XYZ call
contract (known as a ``buy-write''), and the delta of the option is
100, it would be considered ``hedged'' by 50,000 shares of stock.
Accordingly, the proposed rule would not allow the introducing OTP
Holder or OTP Firm to purchase more than 50,000 shares of stock in the
hedging stock position. The Exchange believes that it is reasonable to
require that the hedging position be in amounts that do not exceed the
equivalent size of the related options order on a delta basis, and not
for a greater number of shares. The Exchange believes that the proposed
rule change would support its view that the OTP Holder or OTP Firm
introducing the tied hedge order be guided by the notion that any
excess hedging activity could be detrimental to the eventual execution
price of the option order. Consequently, while delta estimates may vary
slightly, the introducing OTP Holder or OTP Firm would be required to
assume hedging positions not to exceed the equivalent size of the
options order on a delta basis.\17\
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    \17\ The Exchange notes that there may be scenarios where the
introducing OTP Holder or OTP Firm purchases (sells) less than the
delta, e.g., when there is not enough stock available to buy (sell)
at the desired price. In such scenarios, the introducing OTP Holder
or OTP Firm would present the stock that was purchased (sold) and
share it with the in-crowd market participants on equal terms. This
risk of obtaining less than a delta hedge is a risk that exists
under the current rules because of the uncertainty that exists when
market participants price an option and have to anticipate the price
at which they will be able to obtain a hedge. The proposed tied
hedge procedures are designed to help reduce this risk, but the
initiating OTP Holder or OTP Firm may still be unable to execute
enough stock at the desired price. To the extent the initiating OTP
Holder or OTP Firm is able to execute any portion of the hedge, the
risk exposure to the initiating OTP Holder or OTP Firm and the in-
crowd market participants would be diminished because those shares
would be ``tied up'' and available for everyone that participates on
the resulting tied hedge transaction. The Exchange does not believe
that the initiating OTP Holder or OTP Firm would have an unfair
advantage by having the ability to pre-facilitate less than a delta
hedge because the proposed procedures would require the in-crowd
market participants to get a proportional share of the hedge. To the
extent more stock is needed to complete a hedge, the initiating OTP
Holder OTP Firm and the in crowd market participants would have the
same risk exposure that they do today.
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    The Exchange believes that the delta basis requirement, together
with the additional conditions that an introducing OTP Holder or OTP
Firm bring the hedging position without undue delay to the trading
crowd and announce it concurrently with the option order, offer it to
the crowd in its entirety, and offer it at the execution price received
by the OTP Holder or OTP Firm or to any in-crowd market participant who
has established parity or priority, will help assure that the hedging
activity is bona fide and not for speculative or manipulative purposes.
Additionally, the Exchange believes these conditions will help assure
that there is no adverse effect on the auction market because, as
discussed above, in-crowd market participants will have the same
opportunity as the OTP Holder or OTP Firm introducing the tied hedge
order to compete for the option order and will share the same benefits
of limiting the market risk associated with hedging. The Exchange
believes that customers will also benefit if the market risks are
limited in the manner proposed. Once an original order is hedged, there
is no delta risk. With the delta risk minimized, quotes will likely
narrow as market participants (whether upstairs or on-floor) are better
able to hedge and compete for orders. For example, Market-Makers could
more easily quote markets to trade against a customer's original order
based on volatility with the delta risk minimized, which would
ultimately present more price improvement opportunities to the original
order.\18\
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    \18\ The Exchange also believes that the proposed exception to
the anticipatory hedging procedures will assist in the Exchange's
competitive efforts to attract order flow from the OTC market, which
may result in increased volume on the exchange markets.
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    At this time, the Exchange is not proposing any special priority
provisions applicable to tied hedge transactions, though it intends to
evaluate whether such changes are desired and may submit a separate
rule filing on this subject in the future. Under the instant proposal,
all tied hedge transactions will be treated as Complex Orders
(regardless of whether the original order was a simple or complex
order). Priority will be afforded in accordance with the Exchange's
existing open outcry allocation and reporting procedures for Complex
Orders.\19\ Any resulting tied hedge transactions will also be subject
to the existing NBBO trade-through requirements for options and stock,
as applicable. In this regard, the Exchange believes that the resulting
option and stock components of the tied hedge transactions may qualify
for various NBBO trade through exceptions including, for example, the
complex

trade exception to the Options Order Protection And Locked/Crossed
Market Plan \20\ (``Order Protection Plan'') (except in the scenario
where the originating order is a simple order) and the qualified
contingent trade exception to Rule 611(a) of Regulation NMS for the
stock component.\21\
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    \19\ Generally, a Complex Order may be expressed in any
increment and executed at a net debit or credit price with another
OTP Holder or OTP Firm without giving priority to equivalent bids
(offers) in the individual series legs that are represented in the
trading crowd or in the Consolidated Book provided at least one leg
of the order betters the corresponding bid (offer) in the
Consolidated Book. For stock-option orders and security future-
option orders, this means that the options leg of the order has
priority over bids (offers) of the trading crowd but not over bids
(offers) in the Consolidated Book. In addition, for complex orders
with non-option leg(s), such as stock-option orders, a bid or offer
is made and accepted subject to certain other conditions, including
that the options leg(s) may be cancelled at the request of any OTP
Holder or OTP Firm that is a party to the transaction if market
conditions in any other market(s) prevent the execution of the non-
options leg(s) at the agreed price(s). See, e.g., NYSE Arca Rules
6.72, Trading Differentials, 6.75, Priority and Order Allocation
Procedures--Open Outcry, 6.77, Contract Made on Acceptance of Bid or
Offer, and 6.47. Any crossing participation entitlement would also
apply to the tied hedge procedures in accordance with Rule 6.47(b).
    \20\ A ``complex trade'' is defined as: (i) The execution of an
order in an option series in conjunction with the execution of one
or more related orders in different option series in the same
underlying security occurring at or near the same time in a ratio
that is equal to or greater than one-to-three (.333) and less than
or equal to three-to-one (3.0) and for the purpose of executing a
particular investment strategy; or (ii) the execution of a stock
option order to buy or sell a stated number of units of an
underlying stock or a security convertible into the underlying stock
(``convertible security'') coupled with the purchase or sale of
option contract(s) on the opposite side of the market representing
either (A) the same number of units of the underlying stock or
convertible security, or (B) the number of units of the underlying
stock or convertible security necessary to create a delta neutral
position, but in no case in a ratio greater than 8 option contracts
per unit of trading of the underlying stock or convertible security
established for that series by the Options Clearing Corporation. See
paragraph (4) of NYSE Arca Rule 6.92, Definitions (applicable to the
Order Protection Plan), and subparagraph (b)(7) to NYSE Arca Rule
6.94, Order Protection.
    \21\ A ``qualified contingent trade'' is defined as a
transaction consisting of two or more component orders, executed as
agent or principal, where: (i) At least one component order is in an
NMS stock; (ii) all components are effected with a product or price
contingency that either has been agreed to by the respective
counterparties or arranged for by a broker-dealer as principal or
agent; (iii) the execution of one component is contingent upon the
execution of all other components at or near the same time; (iv) the
specific relationship between the component orders (e.g., the spread
between the prices of the component orders) is determined at the
time the contingent order is placed; (v) the component orders bear a
derivative relationship to one another, represent different classes
of shares of the same issuer, or involve the securities of
participants in mergers or with intentions to merge that have been
announced or since cancelled; and (vi) any trade throughs caused by
the execution of an order involving one or more NMS stocks (each an
``Exempted NMS Stock Transaction'') is fully hedged (without regard
to any prior existing position) as a result of the other components
of the contingent trade. See Securities Exchange Act Release No.
57620 (April 4, 2008), 73 FR 19271 (April 9, 2008).
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    The Exchange recognizes that, at the time a tied hedge transaction
is executed in a Trading Crowd, market conditions in any of the non-
options market(s) may prevent the execution of the non-options leg(s)
at the price(s) agreed upon. For example, the execution price may be
outside the non-options market's best bid or offer (``BBO''), e.g., the
stock leg is to be executed at a price of $25.03 and the particular
stock market's BBO is $24.93--$25.02, and such an execution would
normally not be permitted unless an exception applies that permits the
trade to be reported outside the BBO. The Exchange notes that the
possibility of this scenario occurring exists with complex order
executions today and tied hedge transactions would present nothing
unique or novel in this regard. In the event the conditions in the non-
options market continue to prevent the execution of the non-option
leg(s) at the agreed price(s), the trade representing the options
leg(s) of the tied hedge transaction may ultimately be cancelled in
accordance with NYSE Arca's existing rules.\22\
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    \22\ The Exchange notes that, in the event of a cancellation,
OTP Holders and OTP Firms may be exposed to the risk associated with
holding the hedge position. The Exchange intends to address this
point in a circular to OTP Holders and OTP Firms.
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    The following examples illustrate these priority principles:
     Simple Original Order: Introducing member receives an
original customer order to buy 500 XYZ call options, which has a delta
of 100. The introducing member purchases 50,000 shares of XYZ stock on
the NYSE for an average price of $25.03 per share. Once the stock is
executed on the NYSE, the introducing member, without undue delay,
announces the 500 contract option order and 50,000 share tied stock
hedge at $25.03 per share to the NYSE Arca trading crowd.
     Complex Original Order: Introducing member receives an
original customer stock-option order to buy 500 XYZ call options and
sell 50,000 shares of XYZ stock. The introducing member purchases
50,000 shares of XYZ stock on the NYSE for an average price of $25.03
per share. Once the stock is executed on the NYSE, the introducing OTP
Holder or OTP Firm, without undue delay, announces the 500 contract
option order and 50,000 share tied stock hedge at $25.03 per share to
the trading crowd.
    In either the simple or complex order scenario, the next steps are
the same and are no different from the procedures currently used to
execute a Complex Order on NYSE Arca in open outcry.
     The in-crowd market participants would have an opportunity
to provide competing quotes for the tied hedge package (and not for the
individual component legs of the package). For example, assume the best
net price is $24.53 (equal to $0.50 for each option contract and $25.03
for each corresponding share of hedging stock).
     The option order and hedging stock would be allocated
among the in-crowd market participants that established priority or
parity at that price, including the initiating OTP Holder or OTP Firm,
in accordance with the standard allocation procedures, with the options
leg being executed and reported on NYSE Arca and the stock leg being
executed and reported on the stock market specified by the initiating
OTP Holder or OTP Firm.
    For example, the introducing member might trade 40% pursuant to an
open outcry crossing entitlement (200 options contracts and 20,000
shares of stock) and the remaining balance might be with three
different Market-Makers that each participated on 20% of the order (100
options contracts and 10,000 shares of stock per Market-Maker).
     The resultant tied hedge transaction: (i) Would qualify as
a ``complex trade'' under the Order Protection Plan and the execution
of the 500 option contracts with the market participants would not be
subject to the NBBO for the particular option series in the scenario
where the originating order is a complex order (not a simple order);
and (ii) would qualify as a ``qualified contingent trade'' under
Regulation NMS and the execution of the 30,000 shares of stock (the
original 50,000 shares less the initiating member's 20,000 portion)
with the market participants would not be subject to the NBBO for the
underlying XYZ stock.
     The execution of the options leg would have to satisfy the
Exchange's intra-market priority rules for Complex Orders (including
that the execution price may not be outside the NYSE Arca BBO). Thus,
if the Exchange's BBO for the series was $0.40-$0.55, the execution
could take place at or inside that price range (e.g., at the quoted
price of $0.50) and could not take place outside that price range
(e.g., not at $0.56).
     Similarly, the execution of the stock at $25.03 per share
would have to satisfy the intra-market priority rules of the market(s)
where the stock is to be executed (including that the execution price
may not be outside that market's BBO) or, alternatively, qualify for an
exception that permits the trade to be reported outside the executing
market(s)' BBO.
     If market conditions in the executing market(s) prevent
the execution of the stock leg(s) at the price(s) agreed upon from
occurring (e.g., the BBO remains at $24.93-$25.02), then the options
leg(s) could be cancelled at the request of any member that is a party
to that trade.
    While the particular circumstances surrounding each transaction on
the Exchange's trading floor are different, the Exchange does not
believe, as a general proposition, that the tied hedge procedures would
be inherently harmful or detrimental to customers or have an adverse
affect on the auction market. Rather, the Exchange believes the

procedures will improve the opportunities for an order to be exposed to
a competitive auction and represent an improvement over the current
rules. The fact that the parties to such a trade end up fully hedged
may contribute to the best execution of the orders and, in any event,
participants continue to be governed by, among other things, their best
execution responsibilities. The Exchange also believes that the
proposed tied hedge procedures are fully consistent with the original
design of Rule 6.49 which, as discussed above, was designed to
eliminate the unfairness that can be associated with a solicited
transaction and to encourage meaningful competition. The tied hedge
procedures will keep in-crowd market participants on equal footing with
solicited parties in a manner that minimizes all parties' market risk
while continuing to assure that orders are exposed in a meaningful way.
2. Statutory Basis
    The Exchange believes the proposed rule change is consistent with
Section 6(b) of the Act \23\ in general, and furthers the objectives of
Section 6(b)(5) of the Act, in that it is designed to promote just and
equitable principles of trade, remove impediments to and perfect the
mechanisms of a free and open market and a national market system and,
in general, to protect investors and the public interest, as it will
improve the opportunities for an order to be exposed to a competitive
auction and represent an improvement over the current rules and will
keep in-crowd market participants on equal footing with solicited
parties in a manner that minimizes all parties' market risk while
continuing to assure that orders are exposed in a meaningful way.
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    \23\ 15 U.S.C. 78f (b).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange does not believe that the proposed rule change will
impose any burden on competition that is not necessary or appropriate
in furtherance of the purposes of the Act.

C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants or Others

    No written comments were solicited or received with respect to the
proposed rule change.

III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action

    The Exchange has filed the proposed rule change pursuant to Section
19(b)(3)(A)(iii) of the Act \24\ and Rule 19b-4(f)(6) thereunder.\25\
Because the proposed rule change does not: (i) Significantly affect the
protection of investors or the public interest; (ii) impose any
significant burden on competition; and (iii) become operative prior to
30 days from the date on which it was filed, or such shorter time as
the Commission may designate, if consistent with the protection of
investors and the public interest, the proposed rule change has become
effective pursuant to Section 19(b)(3)(A) of the Act \26\ and Rule 19b-
4(f)(6)(iii) thereunder.\27\
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    \24\ 15 U.S.C. 78s(b)(3)(A)(iii).
    \25\ 17 CFR 240.19b-4(f)(6).
    \26\ 15 U.S.C. 78s(b)(3)(A).
    \27\ 17 CFR 240.19b-4(f)(6). In addition, Rule 19b-4(f)(6)(iii)
requires the Exchange to give the Commission written notice of the
Exchange's intent to file the proposed rule change along with a
brief description and text of the proposed rule change, at least
five business days prior to the date of filing of the proposed rule
change, or such shorter time as designated by the Commission. The
Exchange has satisfied the pre-filing requirement.
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    At any time within 60 days of the filing of the proposed rule
change, the Commission may summarily abrogate such rule change if it
appears to the Commission that such action is necessary or appropriate
in the public interest, for the protection of investors, or otherwise
in furtherance of the purposes of the Act.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and
arguments concerning the foregoing, including whether the proposed rule
change is consistent with the Act. Comments may be submitted by any of
the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://
www.sec.gov/rules/sro.shtml ); or
     Send an e-mail to<EMAIL_ADDRESS>Please include
File Number SR-NYSEArca-2009-112 on the subject line.

Paper Comments

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

All submissions should refer to File Number SR-NYSEArca-2009-112. This
file number should be included on the subject line if e-mail is used.
To help the Commission process and review your comments more
efficiently, please use only one method. The Commission will post all
comments on the Commission's Internet Web site (http://www.sec.gov/
rules/sro.shtml). Copies of the submission, all subsequent amendments,
all written statements with respect to the proposed rule change that
are filed with the Commission, and all written communications relating
to the proposed rule change between the Commission and any person,
other than those that may be withheld from the public in accordance
with the provisions of 5 U.S.C. 552, will be available for inspection
and copying in the Commission's Public Reference Room, 100 F Street,
NE., Washington, DC 20549, on official business days between the hours
of 10 a.m. and 3 p.m. Copies of such filing also will be available for
inspection and copying at the principal office of the Exchange. All
comments received will be posted without change; the Commission does
not edit personal identifying information from submissions. You should
submit only information that you wish to make publicly available. All
submissions should refer to File Number SR-NYSEArca-2009-112 and should
be submitted on or before January 8, 2010.

    For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\28\
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    \28\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. E9-30063 Filed 12-17-09; 8:45 am]

BILLING CODE 8011-01-P