Self-Regulatory Organizations; NYSE American LLC; Notice of Filing of Amendment No. 1 and Order Granting Accelerated Approval of a Proposed Rule Change, as Modified by Amendment No. 1, To Allow Certain Flexible Equity Options To Be Cash Settled

I. Introduction

On October 17, 2019, NYSE American LLC (“NYSE American” or “Exchange”) filed with the Securities and Exchange Commission (“Commission”), pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (“Act”) and Rule 19b-4 thereunder, a proposed rule change to amend Rules 903G and 906G to allow certain Flexible Exchange (“FLEX”) Equity Options to be cash settled. The proposal, as modified by Amendment No. 1, would allow FLEX Equity Options to be cash settled where the underlying security is an Exchange-Traded Fund (“ETF”) that meets prescribed criteria (“FLEX ETF Option”).

The proposed rule change was published for comment in the Federal Register on November 7, 2019. On December 18, 2019, the Commission extended the time period within which to approve the proposed rule changes, disapprove the proposed rule changes, or institute proceedings to determine whether to approve or disapprove the proposed rule changes, to February 5, 2020. On February 4, 2020, the Exchange filed Amendment No. 1 to the proposed rule change, which supersedes the original filing in its entirety. The Commission has received no comments on the proposed rule change. The Commission is publishing this notice to solicit comments on Amendment No. 1 from interested persons, and is approving the proposed rule change, as modified by Amendment No. 1, on an accelerated basis.

II. Description of the Proposal, as Modified by Amendment No. 1

The Exchange has proposed to amend NYSE American Rule 903G(c) to allow for cash settlement of certain FLEX Equity Options. FLEX Equity Options permit investors to specify certain options contract terms, within parameters set forth in the Exchange's FLEX rules, such as exercise style, expiration date, and exercise prices. Currently, FLEX Equity Options are settled by physical delivery of the underlying security. The Exchange proposed, in the case of a FLEX Equity Option with an underlying security that is an Exchange-Traded Fund (i.e., a FLEX ETF Option) and that meets prescribed criteria, to allow settlement either by delivery in cash or, as currently permitted under the Exchange rules, by physical delivery of the underlying security.

As proposed, the Exchange would allow for the cash settlement of a FLEX ETF Option if the underlying ETF, measured over the prior six-month period, has (1) an average daily notional value of at least $500 Million; and (2) a national average daily volume (“ADV”) of at least 4,680,000 shares. The Exchange proposed to determine bi-annually the underlying ETFs that satisfy these notional value and trading volume requirements by using trading statistics for the previous six-months. The Exchange also proposed to permit cash settlement as a contract term on no more than 50 underlying ETFs, and that if more than 50 underlying ETFs satisfy the notional value and trading volume requirements, to select the top 50 securities based on the ETFs with the highest ADV after meeting the initial requirements. Further, the Exchange's proposed rule states that if the Exchange determines pursuant to the bi-annual review that an underlying ETF ceases to satisfy the specified criteria, any new position overlying such security entered into would be required to have exercise settlement by physical delivery and any open positions overlying such security would be able to be traded only to close the position.

In support of its proposal, the Exchange stated that it believes it is appropriate to introduce cash settlement as an alternative contract term to the select group of ETFs because they are “among the most highly liquid and actively-traded securities,” and that the deep liquidity and robust trading activity in these ETFs, in the Exchange's view, mitigate against historic concerns regarding susceptibility to manipulation. The Exchange stated that it believes that average daily notional value is an appropriate proxy for selecting underlying ETFs that are not readily susceptible to manipulation because it believes that as a general matter, the more expensive an underlying ETF's price, the less cost-effective manipulation could become, and that manipulation of the price of an ETF encounters greater difficulty the more volume that is traded. In addition, the Exchange stated that it believes an ADV requirement of 4,680,000 shares a day is appropriate because it represents average trading in the underlying ETF of 200 shares per second. The Exchange stated that it believes that while no security is immune from all manipulation, the combination of average daily notional value and ADV as prerequisite requirements would limit cash settlement of FLEX ETF Options to those underlying securities that would be less susceptible to manipulation in order to establish a settlement price. The Exchange further stated that it believes that permitting cash settlement as a contract term for FLEX ETF Options would broaden the base of investors that use FLEX Options to manage their trading and investment risk, including investors that currently trade in the OTC market for customized options, where settlement restrictions do not apply.

The Exchange represented that the table below provides the list of the 26 securities that, as of December 31, 2019, would be eligible to have cash settlement as a contract term.

The Exchange proposed that cash-settled FLEX ETF Options would be subject to the position limits set forth in NYSE American Rule 904 and the exercise limits set forth in NYSE American Rule 905, which rules also apply to the standardized options market. In addition, the Exchange proposed that positions in cash-settled options will be aggregated with all positions in physically-settled options on the same underlying ETF for the purpose of calculating the position limits set forth in Rule 904, and the exercise limits set forth in Rule 905.

The Exchange noted in its filing that cash-settled FLEX ETF Options would not be available for trading until The Options Clearing Corporation (“OCC”) represents to the Exchange that it is fully able to clear and settle such options. The Exchange stated that it represents that it 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 proposed rule change. The Exchange also represented that it does not believe the proposed rule change will cause fragmentation of liquidity. The Exchange further represented that it will monitor for any effects additional trading volume from the proposal may have on both market fragmentation and capacity of the Exchange's automated systems.

The Exchange stated that it believes that it has an adequate surveillance program in place for cash-settled FLEX ETF Options and intends to apply the same program procedures that it applies to the Exchange's other options products. The Exchange represented, among other things, that its existing trading surveillances are adequate to monitor the trading in the underlying securities and subsequent trading of options on those securities on the Exchange, including cash-settled FLEX ETF Options. The Exchange noted that the regulatory program operated by and overseen by NYSE Regulation includes cross-market surveillance designed to identify manipulative and other improper trading that may occur on the Exchange and other markets. The Exchange also represented, among other things, that it believes its existing surveillance technologies and procedures adequately address potential concerns regarding possible manipulation of the settlement value at or near the close of the market. In addition, the Exchange stated that it believes that improvements in audit trails, recordkeeping practices, and inter-exchange cooperation over the last two decades have greatly increased the Exchange's ability to detect and punish attempted manipulative activities.

The Exchange represented that it is a member of the Intermarket Surveillance Group (“ISG”) under the Intermarket Surveillance Group Agreement dated June 20, 1994. The ISG members work together to coordinate surveillance and investigative information sharing in the stock and options markets. For surveillance purposes, the Exchange stated that it would have access to information regarding trading activity in the pertinent underlying securities.

Finally, the Exchange represented that, given the novel characteristics of cash-settled FLEX ETF Options, the Exchange will conduct a review of the trading in cash-settled FLEX ETF Options over an initial five-year period and furnish annual reports to the SEC based on this review. At a minimum, the reports will provide a comparison between the trading volume of all cash-settled FLEX ETF Options listed under the proposed rule and physically-settled options on the same underlying security, the liquidity of the market for such options products and the underlying ETFs, and any manipulation concerns arising in connection with the trading of cash-settled FLEX ETF Options under the proposed rule, and will also discuss any recommendations the Exchange may have for enhancements to the listing standards based on its review.

III. Discussion and Commission Findings

After careful review of the proposal, as modified by Amendment No. 1, the Commission finds that the proposed rule change, as modified by Amendment No. 1, is consistent with the requirements of the Act and the rules and regulations thereunder applicable to a national securities exchange. In particular, the Commission finds that the proposed rule change, as modified by Amendment No. 1, is consistent 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 foster cooperation and coordination with persons engaged in facilitating transactions in securities, to remove impediments to and perfect the mechanism of a free and open market and a national market system, and, in general, to protect investors and the public interest.

The Commission notes that the Exchange's modified proposal would allow cash settlement for FLEX Equity Options only on ETFs, and only where the underlying ETF, as measured over the prior six-month period, has (1) an average daily notional value of at least $500 Million; and (2) a national ADV of at least 4,680,000 shares. The Commission notes, and the Exchange has represented, that the 26 ETFs currently eligible using the proposed criteria appear to be among some of the most liquid and actively-traded ETFs based on their average daily volume and average notional value. The Commission believes that, by limiting the trading of options permitted to have cash settlement to those with underlying ETFs and only where these ETFs are liquid and actively traded, along with the other proposed requirements, appears to be reasonably designed to mitigate concerns about the susceptibility to manipulation of such cash-settled FLEX ETF Options and their underlying ETFs and the potential for market disruption. Additionally, the proposed aggregated position and exercise limits and surveillance procedures discussed below, taken together with the liquid and active markets in the underlying eligible ETFs, also appears reasonably designed to address and mitigate concerns about the potential for manipulation and market disruption in markets for the options and the underlying securities.

The Commission also notes that the Exchange has proposed to use the same position limits and exercise limits for cash-settled FLEX ETF Options that are applicable to the non-FLEX standardized options market, and to aggregate the positions in cash-settled FLEX ETF Options with all positions in physically-settled options on the same underlying ETF for purposes of calculating the position and exercise limits. The Commission has previously recognized that position and exercise limits serve as a regulatory tool designed to address manipulative schemes and adverse market impact surrounding the use of options and that the limits can be useful to prevent investors from disrupting the market in securities underlying the options as well as the options market itself. The Commission believes therefore that establishing position and exercise limits at the same levels as those in the non-FLEX standardized options market and aggregating those positions with all physically-settled options on the same underlying ETFs can further help mitigate the concerns that the limits are designed to address about the potential for manipulation and market disruption in the options and the underlying securities.

The Commission notes that the Exchange will conduct a biannual review of the underlying ETFs to determine whether they no longer meet the requirements for cash-settled FLEX ETF Options on those ETFs. The Commission believes that this requirement is a reasonable means to limit cash settlement to those FLEX ETF Options that only overlie ETFs that continue to meet the specified liquidity and trading volume standards. The Commission also believes that while, as part of the biannual review, the Exchange can identify new underlying ETFs that meet the requirements and are thus eligible for cash-settled FLEX ETF Options, limiting the number of qualifying underlying ETFs to 50 will prevent the scope of cash settlement on FLEX ETF Options from growing considerably without an evaluation about whether the level of the requirements remains reasonable. The Commission further believes that selecting the top 50 securities based on ETFs with the highest ADV, if more than 50 ETFs otherwise meet the requirements in Rule 903(G)(c)(3)(ii), appears to be a reasonable tiebreaker. In addition, the Commission notes that, should the Exchange determine, pursuant to the bi-annual review that an underlying ETF ceases to satisfy the requirements under Rule 903(G)(c)(3)(ii), any new options position overlying such ETF would be required to have exercise settlement by physical delivery and any open cash-settled FLEX ETF Option positions may be traded only to close the position. The Commission believes that this provision is a reasonable means to address how to wind down an outstanding cash-settled FLEX ETF Option where the underlying ETF no longer qualifies under the liquidity and volume criteria, thereby addressing manipulation concerns, while still allowing market participants to close out positions.

The Commission recognizes that the proposal is unique in that it would allow options on ETFs that currently are only available to be traded on a national securities exchange with physical settlement to now have a cash-settlement alternative. The Exchange, acknowledging the “novel characteristics” of its proposal has committed to perform periodic data analyses with written assessments and to make such analyses and assessments available to the Commission on an annual basis for the first five years of trading in the subject options. As noted above, the Exchange has also stated that the reports will discuss any recommendations it has on enhancements to its proposed listing standards based on these reviews. The Commission notes that the annual reports will allow the Commission and the Exchange to evaluate, among other things, the impact such options have, and any potential adverse effects, on price volatility and the market for the underlying ETFs, the component securities underlying the ETFs, and the options on the same underlying ETFs and make appropriate recommendations, if any, in response to the reports.

The Commission notes that surveillance is important, among other things, to detect and deter fraudulent and manipulative trading activity as well as other violations of Exchange rules and the federal securities laws. The Exchange has represented that it has adequate surveillance procedures in place to monitor trading in these options and the underlying securities, including to detect manipulative trading activity in both the options and the underlying ETF. The Exchange further asserted that the liquidity and active markets in the underlying ETFs, and the high number of market participants in both the underlying ETFs and existing options on the ETFs, helps to minimize the possibility of manipulation. The Commission notes that the proposed surveillance, along with the liquidity criteria and position and exercise limits requirements, appear to be reasonably designed to mitigate manipulation concerns. The Commission further notes that under Section 19(g) of the Act, the Exchange, as a self-regulatory organization, is required to enforce compliance by its members and persons associated with its members with the Act, the rules and regulations thereunder, and the rules of the Exchange. The Commission understands that the Exchange performs ongoing evaluations of its surveillance program to ensure its continued effectiveness and the Commission would, therefore, expect the Exchange to continue to review its surveillance procedures on an ongoing basis and make any necessary enhancements and/or modifications that may be needed for the cash settlement of FLEX ETF Options.

In approving the proposed rule change, the Commission notes that cash-settled FLEX ETF Options will be subject to the same trading rules and procedures that currently govern the trading of other FLEX Options on the Exchange, with the exception of the rules to accommodate the cash settlement feature being approved herein. The Commission also notes that the Exchange has represented that it will monitor any effect additional options series listed under the proposal have on market fragmentation and the capacity of the Exchange's automated systems. The Commission notes that FLEX ETF Options, as the Exchange represented, cannot be traded until OCC represents to the Exchange that it is fully able to clear and settle such options. Finally, the Commission expects that the Exchange will take prompt action, including timely communication with the Commission and with other self-regulatory organizations responsible for oversight of trading in options, the underlying ETFs, and the ETFs' component securities, should any unanticipated adverse market effects develop.

Based on the Exchange's representations with respect to the proposed cash-settlement of FLEX Equity Options, whose underlying security is an ETF, and for the foregoing reasons, the Commission finds that the proposed rule change, as modified by Amendment No. 1, is consistent with the Act.

IV. Accelerated Approval of Proposed Rule Change, as Modified By Amendment No. 1

The Commission finds good cause to approve the proposed rule change, as modified by Amendment No. 1, prior to the thirtieth day after the date of publication of notice of the filing of Amendment No. 1 in the Federal Register. As discussed above, Amendment No. 1 modified the original proposed rule change to limit the cash settlement of FLEX Equity Options to underlying ETFs, with a maximum cap of 50 such ETFs, that have met the originally proposed average daily notional value and national average daily volume requirements, using average daily volume as a tiebreaker if more than 50 ETFs otherwise qualify. Amendment No 1 also modified the original proposal to require that the proposed position and exercise limits for cash-settled FLEX ETF Options be aggregated with all physically-settled options on the same underlying ETF. Amendment No. 1 stated that the Exchange would provide a report to the Commission annually for five years providing an analysis, along with any recommendations, concerning the trading of cash-settled FLEX ETF Options. Finally, Amendment No. 1 made some additional clarifying changes to the original proposal.

The Commission notes that the changes made to the original proposal in Amendment No. 1 narrows the scope of the proposed rule change and limits its applicability to ETFs, which should help to mitigate potential risks of manipulation and market disruption. The amendment to aggregate position and exercise limits also addressed similar concerns. Furthermore, the Commission notes that the original, broader proposal, including the proposed numerical eligibility criteria applied to the underlying ETFs, was published for comment in the Federal Register and no comments were received. The Exchange's annual report requirement also supplements the proposal and should help the Exchange and the Commission in assessing any potential market impacts, including on price volatility, from the trading of the cash-settled FLEX ETF Options under the proposal. In addition, Amendment No. 1 clarifies and provides additional explanation relating to the proposed rule change. The changes and additional information in Amendment No. 1 have also assisted the Commission in evaluating the proposal and finding that the proposal is consistent with the Act.

Accordingly, the Commission finds good cause, pursuant to Section 19(b)(2) of the Act, to approve the proposed rule change, SR-NYSEAMER-2019-38, as modified by Amendment No. 1, on an accelerated basis.

V. Solicitation of Comments on Amendment No. 1 to the Proposed Rule Change

Interested persons are invited to submit written data, views, and arguments concerning the foregoing, including whether Amendment No. 1 to 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-NYSEAMER-2019-38 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-2019-38. 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 the 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-2019-38 and should be submitted on or before March 3, 2020.

VI. Conclusion

It is therefore ordered, pursuant to Section 19(b)(2) of the Act, that the proposed rule change (SR-NYSEAMER-2019-38), as modified by Amendment No. 1, be, and hereby is, approved.