Self-Regulatory Organizations; Nasdaq PHLX LLC; Notice of Filing of Proposed Rule Change To Amend FLEX Floor Trading Rules

Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (“Act”), and Rule 19b-4 thereunder, notice is hereby given that on October 8, 2024, Nasdaq PHLX LLC (“Phlx” or “Exchange”) filed with the Securities and Exchange Commission (“SEC” or “Commission”) the proposed rule change as described in Items I, II, and III below, which Items have been prepared by the Exchange. The Commission is publishing this notice to solicit comments on the proposed rule change from interested persons.

I. Self-Regulatory Organization's Statement of the Terms of Substance of the Proposed Rule Change

The Exchange proposes to amend Options 8, Section 34, FLEX Trading.

The text of the proposed rule change is available on the Exchange's website at https://listingcenter.nasdaq.com/rulebook/phlx/rules, at the principal office of the Exchange, and at the Commission's Public Reference Room.

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

In its filing with the Commission, the Exchange included statements concerning the purpose of and basis for the proposed rule change and discussed any comments it received on the proposed rule change. The text of these statements may be examined at the places specified in Item IV below. The Exchange has prepared summaries, set forth in sections A, B, and C below, of the most significant aspects of such statements.

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

1. Purpose

The Exchange proposes to amend Options 8, Section 34, FLEX Trading. The Exchange also proposes a technical amendment to Options 8, Section 33, Accommodation Transactions.

Options 8, Section 34

FLEX Options are customized equity, index, and currency contracts that allow investors to tailor contract terms for exchange-listed equity and index options. By way of background, in 2023, the Exchange filed a rule change to amend the manner in which FLEX Options are transacted on Phlx's Trading Floor. Thereafter, the Exchange filed to delay the implementation of SR-Phlx-2023-22 to on or before August 30, 2024. Finally, in 2024, Phlx filed a rule change to amend FLEX Options rules at Options 8, Section 34(b) and further delay the implementation of SR-Phlx-2023-22 to the end of Q4 2025. At this time, the Exchange proposes to further amend the rules proposed in SR-Phlx-2023-22 and SR-Phx-2024-24, which are immediately effective, but not yet operative. The Exchange proposes to implement the amendments in Phlx-2023-22 and SR-Phx-2024-24 at the same time as the proposed amendments.

Specifically, the Exchange proposes to (1) clarify the Options 8, Section 34 functionality that will be available with the implementation of SR-Phlx-2023-22 and SR-Phx-2024-24; (2) list p.m.-settled FLEX Index Options whose exercise settlement value is derived from closing prices on the last trading day prior to expiration that expire on or within two business days of a third Friday-of-the-month expiration day for a non-FLEX Option; and (2) permit FLEX Options on certain Exchange-Traded Funds (“ETFs”) to be settled by delivery in cash if the underlying security meets prescribed criteria. Each change will be described below.

Options 8, Section 34

First, the Exchange proposes to capitalize certain terms uniformly throughout Options 8, Section 34. The Exchange proposes to capitalize the following terms: “FLEX Options,” “FLEX Equity Options,” “FLEX Index Options,” and “FLEX Currency Options.” The Exchange proposes to amend Options 8, Section 34(f)(4) to define FLEX U. S. dollar-settled foreign currency options as “FLEX Currency Options.”

Second, the Exchange proposes to exclude iShares Bitcoin Trust ETF (“IBIT”) from trading as a FLEX Options.

Third, the Exchange proposes to adopt a new Options 8, Section 34(f)(1)(B) to state, “an underlying equity security or index, as applicable (the index multiplier for FLEX Index Options is 100).” This proposed rule text reflects the current characteristics of underlying interest for FLEX Option. The proposed rule text brings greater clarity to the Rule.

Fourth, the Exchange proposes to amend the language in Options 8, Section 34(f)(3) which was initially amended to state, “The Exchange may determine the smallest increment for exercise prices of FLEX Options not to exceed two decimal places.” While not substantively amending the exercise price, the Exchange proposes to amend this sentence to state, “The Exchange may determine the smallest increment for exercise prices of FLEX Options on a class-by-class basis without going lower than the $0.01.” The Exchange believes that the proposed rule text brings greater clarity to Phlx's rule text and is consistent with rule text in Cboe Rule 5.3(e)(3).

Fifth, the Exchange proposes to amend the language in Options 8, Section 34(f)(5) to provide, “The expiration date may be any business day (specified to the day, month, and year) no more than 15 years from the date on which an executed FLEX equity and index option is submitted to the System and no more than 3 years from the date on which an executed FLEX currency option is submitted to the System with exercise settlement value on the expiration date determined by reference to the reported level of the index as derived from the opening prices of the component securities (“a.m. settlement”) or closing prices (“p.m. settlement”).” This amendment aligns the rule text related to settlement style required for a complex FLEX Order leg with rule text in Cboe 4.21(b)(4). The Exchange notes that Cboe recently received approval of its pilot program that permitted it to list p.m.-settled FLEX Index Options whose exercise settlement value is derived from closing prices on the last trading day prior to expiration that expire on or within two business days of a third Friday-of-the-month expiration day for a non-FLEX Option (“FLEX PM Third Friday Options”). Consistent with the Commission's approval of Cboe's proposal, the Exchange is proposing to allow the listing of FLEX PM Third Friday Options on Phlx as well, and will align with Cboe Rule 4.21(b)(5)(B)(ii).

Sixth, the Exchange proposes to re-style Options 8, Section 34(f)(6) to change the title from “Settlement” to “Settlement type.” The Exchange also proposes to add a title at (A), “FLEX Equity Options.” At proposed Options 8, Section 34(f)(6)(A)(1) the Exchange proposes to add rule text to state “FLEX Options, other than as permitted in subparagraph (2) below, are settled with physical delivery of the underlying security.” The Exchange proposes to also introduce FLEX Equity Options that are cash-settled in proposed Options 8, Section 34(f)(6)(A)(2). The Exchange will discuss cash-settled FLEX Equity Options in greater detail below. The Exchange proposes to amend Options 8, Section 34(f)(6)(A) to add a title for FLEX Index Options at (B) and change the current rule text to instead provide that FLEX Index Options may be specified as the index value reported at the

(1) close (P.M.-settled); and (with exercise settlement value determined by reference to the reported level of the index derived from the reported closing prices of the component securities);

(2) opening (A.M.-settled) of trading on the Exchange (with exercise settlement value determined by reference to the reported level of the index derived from the reported opening prices of the component securities).

While not substantively amending the rule text, the Exchange believes that the proposed text adds clarity by noting how the exercise value is determined depending on whether the option is a.m.-settled or p.m.-settled. The Exchange proposes to add a title “FLEX Currency Options” to new Options 8, Section 34(f)(6)(C). The Exchange also proposes a technical amendment to underline “Market Maker” in Options 8, Section 34(g)(3). SR-Phlx-2023-22 inadvertently did not underline that text, thereby designating it as new text.

Seventh, the Exchange proposes to amend Position Limits in Options 8, Section 34(i) to add a new paragraph stating that,

There shall be no position limits for FLEX Equity Options, other than as set forth in this paragraph and (4) below. Position limits for FLEX Equity Options where the underlying security is an ETF that is settled in cash pursuant to subparagraph (f)(6)(A) shall be subject to the position limits set forth in Options 9, Section 13, and subject to the exercise limits set forth in Options 9, Section 15. Positions in such cash-settled FLEX Options shall be aggregated with positions in physically-settled options on the same underlying ETF for the purpose of calculating the position limits set forth in Options 9, Section 13, and the exercise limits set forth in Options 9, Section 15.

The Exchange will describe position limits for an ETF that is settled in cash below with the description of its proposal to permit a cash-settled ETF.

The Exchange proposes to remove certain numbering as unnecessary in proposed Options 8, Section 34(i)(2), which is currently Options 8, Section 34(i)(1). The Exchange would create a new Options 8, Section 34(i)(2) and title it “Reports.” The Exchange would remove “However” from this new paragraph and start the paragraph with “Each.”

The Exchange proposes to add the tile “Additional Margin Requirements” to proposed Options 8, Section 34(i)(3).

The Exchange proposes to amend proposed Options 8, Section 34(i)(3), current Options 8, Section 34(i)(3), by renumbering it to “(4)” and adding a title “Aggregation of FLEX Positions.” Further, the Exchange proposes to note that, “For purposes of the position limits and reporting requirements set forth in this Rule, FLEX Option positions shall not be aggregated with positions in non-FLEX Options other than as noted in this subparagraphs (i)(3) and (4), and positions in FLEX Index Options on a given index shall not be aggregated with options on any stocks included in the index or with FLEX Index Option positions on another index.” Pursuant to proposed Options 8, Section 34(i)(4)(a), commencing at the close of trading two business days prior to the last trading day of the calendar quarter, positions in P.M.-settled FLEX Index Options ( i.e., FLEX Index Options having an exercise settlement value determined by the level of the index at the close of trading on the last trading day before expiration) shall be aggregated with positions in Quarterly Options Series on the same index with the same expiration and shall be subject to the position limits set forth in Options 4A, Section 6. Pursuant to proposed Options 8, Section 34(i)(4)(b), commencing at the close of trading two business days prior to the last trading day of the week, positions in FLEX Index Options that are cash settled shall be aggregated with positions in Short Term Option Series on the same underlying ( e.g., same underlying index as a FLEX Index Option) with the same means for determining exercise settlement value ( e.g., opening or closing prices of the underlying index) and same expiration, and shall be subject to the position limits set forth in Options 4A, Section 6. Pursuant to proposed Options 8, Section 34(i)(4)(c), as long as the options positions remain open, positions in FLEX Options that expire on a third Friday-of-the-month expiration day shall be aggregated with positions in non-FLEX Options on the same underlying, and shall be subject to the position limits set forth in Options 4A, Section 6, or Options 9, Section 13, as applicable, and the exercise limits set forth in Options 9, Section 15, as applicable.

Eighth, the Exchange proposes to amend Exercise Limits in Options 8, Section 34(j) to provide further detail and rearrange the rule text. The Exchange proposes to relocate the rule text in Options 8, Section 34(j)(1) that provides, “Positions in FLEX options shall not be taken into account when calculating exercise limits for non-FLEX options, except as provided in paragraph (d) above. The minimum exercise size shall be the lesser of $1 million underlying equivalent value for FLEX index options, and 25 contracts for FLEX equity and currency options, or the remaining size of the position.” Instead, the Exchange proposes to provide at Options 8, Section 34(j)(1)(a) that, “The minimum value size for FLEX Equity Option exercises shall be 25 contracts or the remaining size of the position, whichever is less.” Proposed Options 8, Section 34(j)(1)(b) will require that the minimum value size for FLEX Index Option exercises be $1 million Underlying Equivalent Value (as defined below) or the remaining Underlying Equivalent Value of the position, whichever is less. Proposed Options 8, Section 34(j)(1)(c) will stipulate that except as provided in proposed subparagraph (i) and (i)(4) above, FLEX Options shall not be taken into account when calculating exercise limits for non-FLEX Option contracts. Proposed Options 8, Section 34(j)(1)(d) will set forth the definition of Underlying Equivalent Value as the aggregate value of a FLEX Index Option (index multiplier times the current index value) multiplied by the number of FLEX Index Options. Finally, the Exchange proposes to add a sentence to the end of Options 8, Section 34(j) that provides, “There shall be no exercise limits for broad-based FLEX Index Options (including reduced value option contracts) on the broad-based index options listed in Options 4A, Section 6(a).”

Options 8, Section 33

The Exchange also proposes to make a technical amendment to Options 8, Section 33, Accommodation Transactions, at paragraph (e) to remove correct improperly placed parentheticals from SR-Phlx-2024-22.

Cash-Settled Exchange Traded Funds (“ETFs”)

Generally, FLEX Equity Options will be settled by physical delivery of the underlying security, while all FLEX Index Options will be settled by delivery in cash. The Exchange proposes to allow FLEX Equity Options where the underlying security is an ETF to be settled by delivery in cash if the underlying security meets prescribed criteria. The Exchange notes that cash-settled FLEX ETF Options will be subject to the same trading rules and procedures described in Options 8, Section 34 that will govern the trading of other FLEX Options on the Exchange, with the exception of the rules to accommodate the cash-settlement feature proposed as follows. Today, NYSE American Rule 903G and Cboe Rule 4.21(b)(5)(A) allow for cash-settled FLEX ETF Options as well.

To permit cash settlement of certain FLEX ETF Options, the Exchange proposes rule text in Options 8, Section 34(f)(6)(A)(2) to provide that the exercise settlement for a FLEX ETF Option may be by physical delivery of the underlying ETF or by delivery in cash if the underlying security, measured over a defined six-month period, has an average daily notional value of $500 million or more and a national average daily volume (“ADV”) of at least 4,680,000 shares.

The Exchange also proposes in Options 8, Section 34(f) that a FLEX Equity Option overlying an ETF (cash- or physically-settled) may not be the same type (put or call) and may not have the same exercise style, expiration date, and exercise price as a non-FLEX Equity Option overlying the same ETF. In other words, regardless of whether a FLEX Equity Option overlying an ETF is cash or physically settled, at least one of the exercise style ( i.e., American-style or European-style), expiration date, and exercise price of that FLEX Option must differ from those terms of a non-FLEX Option overlying the same ETF in order to list such a FLEX Equity Option. For example, suppose a non-FLEX SPY option (which is physically settled, p.m.-settled and American-style) with a specific September expiration and exercise price of 475 is listed for trading. A FLEX Trader could not submit an order to trade a FLEX SPY option (which is p.m.-settled) that is cash-settled (or physically settled) and American-style with the same September expiration and exercise price of 475.

In addition, the Exchange proposes new Options 8, Section 34(f)(6)(A)(2)(a), which would provide that the Exchange will determine bi-annually the underlying ETFs that satisfy the notional value and trading volume requirements in (f)(6)(A)(2) by using trading statistics for the defined six-month period. The proposed rule would further provide that the Exchange will permit cash settlement as a contract term on no more than 50 underlying ETFs that meet the criteria in this subparagraph (f)(6)(A)(2) and that if more than 50 underlying ETFs satisfy the notional value and trading volume requirements, then the Exchange would select the top 50 ETFs that have the highest average daily volume.

Proposed new Options 8, Section 34(f)(6)(A)(2)(b) would further provide that if the Exchange determines pursuant to the bi-annual review that an underlying ETF ceases to satisfy the requirements under proposed (f)(6)(A)(2)(a), any new position overlying such ETF entered into will 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 Exchange 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 ETF securities. As described more fully below, the Exchange believes that the deep liquidity and robust trading activity in the ETFs identified by the Exchange as meeting the criteria mitigate against historic concerns regarding susceptibility to manipulation.

Characteristics of ETFs

ETFs are funds that have their value derived from assets owned. The net asset value (“NAV”) of an ETF is a daily calculation that is based off the most recent closing prices of the assets in the fund and an actual accounting of the total cash in the fund at the time of calculation. The NAV of an ETF is calculated by taking the sum of the assets in the fund, including any securities and cash, subtracting out any liabilities, and dividing that by the number of shares outstanding.

Additionally, each ETF is subject to a creation and redemption mechanism to ensure the price of the ETF does not fluctuate too far away from its NAV—which mechanisms reduce the potential for manipulative activity. Each business day, ETFs are required to make publicly available a portfolio composition file that describes the makeup of their creation and redemption “baskets” ( i.e., a specific list of names and quantities of securities or other assets designed to track the performance of the portfolio as a whole). ETF shares are created when an Authorized Participant, typically a market maker or other large institutional investor, deposits the daily creation basket or cash with the ETF issuer. In return for the creation basket or cash (or both), the ETF issues to the Authorized Participant a “creation unit” that consists of a specified number of ETF shares. For instance, IWM is designed to track the performance of the Russell 2000 Index. An Authorized Participant will purchase all the Russell 2000 constituent securities in the exact same weight as the index prescribes, then deliver those shares to the ETF issuer. In exchange, the ETF issuer gives the Authorized Participant a block of equally valued ETF shares, on a one-for-one fair value basis. This process can also work in reverse. A redemption is achieved when the Authorized Participant accumulates a sufficient number of shares of the ETF to constitute a creation unit and then exchanges these ETF shares with the ETF issuer, thereby decreasing the supply of ETF shares in the market.

The principal, and perhaps most important, feature of ETFs is their reliance on an “arbitrage function” performed by market participants that influences the supply and demand of ETF shares and, thus, trading prices relative to NAV. As noted above, new ETF shares can be created and existing shares redeemed based on investor demand; thus, ETF supply is open-ended. This arbitrage function helps to keep an ETF's price in line with the value of its underlying portfolio, i.e., it minimizes deviation from NAV. Generally, in the Exchange's view, the higher the liquidity and trading volume of an ETF, the more likely the price of the ETF will not deviate from the value of its underlying portfolio, making such ETFs less susceptible to price manipulation.

Trading Data for the ETFs Proposed for Cash Settlement

The Exchange believes that average daily notional value is an appropriate proxy for selecting underlying securities that are not readily susceptible to manipulation for purposes of establishing a settlement price. Average daily notional value considers both the trading activity and the price of an underlying security. As a general matter, the more expensive an underlying security's price, the less cost-effective manipulation could become. Further, manipulation of the price of a security encounters greater difficulty the more volume that is traded. To calculate average daily notional value (provided in the table below), the Exchange summed the notional value of each trade for each symbol ( i.e., the number of shares times the price for each execution in the security) and divided that total by the number of trading days in the six-month period (from January 1, 2024 through June 30, 2024) reviewed by the Exchange.

Further, the Exchange proposes that qualifying ETFs also meet an ADV standard. The purpose for this second criteria is to prevent unusually expensive underlying securities from qualifying under the average daily notional value standard while not being one of the most actively traded securities. The Exchange 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. While no security is immune from all manipulation, the Exchange believes that the combination of average daily notional value and ADV as prerequisite requirements would limit cash settlement of FLEX ETF Options to those underlying ETFs that would be less susceptible to manipulation in order to establish a settlement price.

The Exchange believes that the proposed objective criteria would ensure that only the most robustly traded and deeply liquid ETFs would qualify to have cash settlement as a contract term. As provided in the below table, from January 1, 2024 to June 30, 2024, the Exchange would be able to provide cash settlement as a contract term for FLEX ETF Options on 48 underlying ETFs, as only this group of securities would currently meet the requirement of $500 million or more average daily notional value and a minimum ADV of 4,680,000 shares. The table below provides the list of the 48 ETFs that, for the period covering January 1, 2024 through June 30, 2024, would be eligible to have cash settlement as a contract term.