[Federal Register Volume 74, Number 36 (Wednesday, February 25, 2009)]
[Notices]
[Pages 8591-8594]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E9-4036]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-59417; File No. SR-CBOE-2008-115]


Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Notice of Filing of Amendments No. 1 and 2 and Order 
Granting Accelerated Approval to a Proposed Rule Change, as Modified by 
Amendments No. 1 and 2 Thereto, Relating to FLEX Options Expirations

February 18, 2009.

I. Introduction

    On November 19, 2008, Chicago Board Options Exchange, Incorporated 
(``CBOE'' or ``Exchange''), filed with the Securities and Exchange 
Commission (``Commission''), pursuant to Section 19(b)(1) of the 
Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change to amend its rules regarding 
permissible expiration dates for Flexible Exchange Options (``FLEX 
Options''). On December 15, 2008, the proposed rule change was 
published for comment in the Federal Register.\3\ On January 28, 2009, 
the Exchange filed Amendment No. 1 \4\ and on February 12, 2009, the 
Exchange filed Amendment No. 2.\5\ The Commission received no comments 
on the proposed rule change. This order provides notice of filing of 
Amendments No. 1 and 2 to the proposed rule change and grants 
accelerated approval to the proposed rule change, as modified by 
Amendments No. 1 and 2.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 59060 (December 5, 
2008), 73 FR 76075 (``Notice'').
    \4\ In Amendment No. 1, the Exchange: (1) Further amended Rules 
24A.7, 24A.8, 24B.7 and 24B.8 to clarify the applicable exercise 
limits for FLEX Options that expire on a third Friday-of-the-month 
expiration day (``Expiration Friday''); (2) made a typographical 
correction to the rule text proposed to be added to Rule 24A.7.
    \5\ In Amendment No. 2, the Exchange (1) further amended Rules 
24A.4 and 24B.4 to impose additional restrictions on FLEX Options 
that expire on any business day that falls on, or within two 
business days of, an Expiration Friday by specifying that they may 
only have an a.m. exercise settlement value: (2) made a technical 
correction to the reference to the Exchange Rules contained in 
footnote 6 of the original proposed rule change.
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II. Description of the Proposal

    Under current CBOE Rules 24A.4 and 24B.4, FLEX Options \6\ may not 
expire on any business day that falls on, or within two business days 
of, an Expiration Friday.\7\
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    \6\ FLEX Options (FLEX Index Options and FLEX Equity Options) 
provide investors with the ability to customize basic option 
features including size, expiration date, exercise style, and 
certain exercise prices. FLEX Index Options and Flex Equity Options 
are index options and options on specified equity securities, 
respectively, that are subject to the FLEX rules in Chapters XXIVA 
or XXIVB of the CBOE Rules. FLEX Index Options Series may be 
approved and open for trading on any index that has been approved 
for Non-FLEX Options trading or for warrant trading on the Exchange. 
FLEX Equity Options transactions are limited to transactions in 
options on underlying securities that have been approved by the 
Exchange in accordance with CBOE Rule 5.3, which includes, but is 
not limited to, stock options and exchange-traded fund options. In 
addition, other products are permitted to be traded pursuant to the 
FLEX trading procedures. For example, credit options are eligible 
for trading as FLEX Options pursuant to the FLEX rules in Chapters 
XXIVA and XXIVB. See CBOE Rules 24A.1(e) and (f), 24A.4(b)(1) and 
(c)(1), 24B.1(f) and (g), 24B.4(b)(1) and (c)(1), and 28.19.
    \7\ For example, under the current rule, a FLEX Option could 
expire on the Tuesday before Expiration Friday, but could not expire 
on the Wednesday or Thursday before Expiration Friday. Similarly, a 
FLEX Option could expire on the Wednesday after Expiration Friday, 
but could not expire on the Monday or Tuesday after Expiration 
Friday. However, subject to certain aggregation requirements for 
cash settled options, the current FLEX Rules do permit the 
expiration of FLEX Options on the same day that Non-FLEX quarterly 
index options (``QIX'') and Non-FLEX Weeklys Options expire.
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    In this proposed rule change, the Exchange proposed to eliminate 
the expiration date restriction on FLEX Options expiring on or within 
two business days of Expiration Friday (``Blackout Period'') so that 
FLEX Options may expire on any business day. Under its proposal, 
position and exercise limits, as applicable under CBOE Rules, and 
reporting requirements would continue to apply.\8\ The

[[Page 8592]]

Exchange further noted that both the Exchange and its member 
organizations each have the authority, pursuant to CBOE Rule 12.10, to 
impose additional margin requirements as deemed advisable.
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    \8\ FLEX Index Options overlying all industry indexes, all micro 
narrow-based indexes, and certain broad-based indexes are subject to 
position and exercise limits under CBOE Rules 24A.7, 24A.8, 24B.7, 
and 24B.8 and will continue to be under the proposal. FLEX Index 
Options on certain other broad-based indexes (specifically the BXM, 
DJX, NDX, OEX, RUT, SPX, VIX, VXD, VXN, XEO, CBOE S&P 500 Three-
Month Realized Variance and S&P 500 Three-Month Realized 
Volatility), and FLEX Equity Options are not subject to position 
limits but would remain subject to reporting requirements under CBOE 
Rules 24A.7 and 24B.7, as is currently the case. Additionally, all 
FLEX Options remain subject to the position reporting requirements 
of CBOE Rule 4.13(a).
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    In addition to the position and exercise limits and reporting 
requirements described above, for FLEX Options that expire on 
Expiration Friday, the Exchange proposed to impose an aggregation 
requirement for position and exercise limit purposes. Specifically, for 
as long as the options positions remain open, positions in FLEX Options 
that expire on Expiration Friday would be aggregated with positions in 
Non-FLEX Options on the same underlying (e.g., the same underlying 
security in the case of a FLEX Equity Option and the same underlying 
index in the case of a FLEX Index Option) (``comparable Non-FLEX 
Options''). Such aggregated FLEX Options and comparable Non-FLEX 
Options would be subject to the same position and exercise limits that 
are applicable to the Non-FLEX Options.\9\ The aggregation requirement 
would apply to both cash and physically settled options.
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    \9\ See proposed CBOE Rules 24A.7(d)(3) and 24B.7(d)(3). The 
applicable position limits are set forth in Rules 4.11, 24.4, 24.4A, 
24.4B, and 29.5. The applicable exercise limits are set forth in 
Rules 4.12, 24.5, and 29.7. The Commission notes that certain broad-
based Index Options traded in CBOE's standardized option market do 
not have position and exercise limits and this would continue to be 
the case when they become fungible with FLEX positions. See Rule 
24.4 (Position Limits for Broad-Based Index Options).
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    Further, in the case of FLEX Index Options only, FLEX Index Options 
expiring within the Blackout Period may only have an a.m. exercise 
settlement value.\10\ Currently, FLEX Index Options that expire on any 
day outside the Blackout Period can have an exercise settlement value 
determined by reference to one of three values: (i) An a.m. exercise 
settlement value; (ii) a p.m. exercise settlement value; \11\ or (iii) 
an average index value, provided that it conforms to the averaging 
parameters, if any, established by the Exchange. Under CBOE's proposal, 
FLEX Index Options expiring within the Blackout Period could only have 
an a.m. settlement and would be prohibited from having a p.m. 
settlement or a settlement value based on an average index value.\12\
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    \10\ An opening exercise settlement value (``a.m. settlement'') 
is determined by reference to the reported level of the index as 
derived from opening prices of the component securities.
    \11\ A closing exercise settlement value (``p.m. settlement'') 
is determined by reference to the reported level of the index as 
derived from the closing prices of the component securities. See 
CBOE Rules 24A.4(b)(3) and 24B.4(b)(3).
    \12\ See Amendment No. 2.
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    In conjunction with the elimination of the expiration date 
restriction, the Exchange also proposed that FLEX Options be permitted 
in puts and calls that do not have the same exercise style, same 
expiration date and same exercise price as Non-FLEX Options that are 
already available for trading on the same underlying security or index, 
provided the options on an underlying security or index are otherwise 
eligible for FLEX trading.\13\ The proposed rules, however, allow FLEX 
Options to be traded before (but not after) the options are listed for 
trading as Non-FLEX Options. Once an outstanding FLEX Option series is 
listed for trading as a Non-FLEX Option series, (i) all existing open 
positions established under the FLEX trading procedures would be fully 
fungible with transactions in the respective Non-FLEX Option series, 
and (ii) any further trading in the series would be as Non-FLEX options 
subject to the Non-FLEX trading procedures and rules.\14\
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    \13\ See proposed CBOE Rules 24A.4 and 24B.4, Section 0.2 of 
Interpretations and Policies.
    \14\ See proposed CBOE Rules 24A.4 and 24B.4, Section 0.2 of 
Interpretations and Policies.
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III. Discussion

    After careful review, the Commission finds that the proposed rule 
change is consistent with the requirements of the Act and the rules and 
regulations thereunder applicable to a national securities 
exchange.\15\ In particular, the Commission finds that the proposed 
rule change is consistent with Section 6(b)(5) of the Act,\16\ in that 
it is designed, among other things, to prevent fraudulent and 
manipulative acts and practices; to promote just and equitable 
principles of trade; to remove impediments to and perfect the mechanism 
of a free and open market and a national market system; and, in 
general, to protect investors and the public interest.
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    \15\ In approving these proposed rule changes, the Commission 
has considered the proposed rules' impact on efficiency, 
competition, and capital formation. 15 U.S.C. 78c(f).
    \16\ 15 U.S.C. 78f(b)(5).
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    The Commission notes that the FLEX Option rules and the Blackout 
Period were initially proposed by the Exchange in October of 1992 and 
approved by the Commission in February of 1993.\17\ At the time the 
FLEX rules were first introduced, the Commission was very concerned 
about the adverse effects of exercise settlements based on the closing 
values of the component securities in indexes. Accordingly, while the 
FLEX Options rules permitted p.m. settlements in certain cases, to 
address these concerns the Exchange adopted the settlement restrictions 
described above that prohibited FLEX Options from expiring on, or 
within, two business days of an Expiration Friday. In approving the 
first FLEX Options rules, applicable to certain broad-based indexes 
only, the Commission stated that while it `` * * * continues to believe 
that basing the settlement of index products on opening as opposed to 
closing prices on Expiration Fridays helps alleviate stock market 
volatility, * * *'' these concerns are reduced in the case of Flex 
Options, since expiration of these stock options will not correspond to 
the normal expirations of other options and futures on Expiration 
Fridays thereby diminishing the impact that FLEX Options could have on 
the market.\18\ Further, in approving the CBOE FLEX market for 
individual equity options, the Commission further reiterated its 
concerns and stated that restricting expirations during the Blackout 
Period would reduce the possibility that expirations of FLEX Equity 
Options would cause additional pressure on the market for the 
underlying securities when Non-FLEX Options expire.\19\
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    \17\ See Securities Exchange Act Release Nos. 31361 (October 27, 
1992), 57 FR 52655 (November 4, 1992) (SR-CBOE-92-17)(notice of 
filing of proposed rule change relating to FLEX Options) and 31920 
(February 24, 1993), 58 FR 12280 (March 3, 1993) (Order approving 
SR-CBOE-92-17).
    \18\ In its filing, the Exchange noted that, at the time of its 
1992 proposal, the Exchange anticipated that there would be limited 
secondary trading in any FLEX Option series having a particular 
expiration date due to the diversity inherent in FLEX Options and 
that FLEX expiration concentrations should be rare. According to the 
Exchange, these observations appear to be accurate for the trading 
in FLEX Options to date and the Exchange anticipates this trend to 
continue.
    \19\ See Securities Exchange Act Release No. 36841 (February 14, 
1996), 61 FR 6666 (February 21, 1996).
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    As stated by the Exchange in its filing, it no longer believes that 
the Blackout Period is necessary to insulate Non-FLEX expirations from 
the potential adverse market impacts of FLEX expirations \20\ and that 
the restriction places the Exchange at a competitive disadvantage to 
its over-the-counter

[[Page 8593]]

(``OTC'') and futures counter-parts in the market for customized 
options.
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    \20\ The Exchange stated that its experience in trading FLEX 
Options to date has shown the relatively small percentage of FLEX 
Options trading compared to overall trading on the Exchange and the 
lack of market disruptions or problems caused by or on existing FLEX 
Option expirations. In further support of its proposal, the Exchange 
noted that it is not aware of any market disruptions or problems 
caused by customized options in the OTC or futures markets that 
expire on or near Expiration Friday. Finally, the Exchange has 
represented that OCC can configure its systems to support the 
expiration of FLEX Options on any business day.
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    The Commission continues to support the use of a.m. settlements in 
index options to reduce the potential for adverse effects on the 
underlying component securities. However, the Commission believes the 
current CBOE's proposal to eliminate the Blackout Period for expiring 
FLEX Options, including FLEX Index Options, has been appropriately 
structured by requiring a.m. settlements for FLEX Index Options,\21\ 
requiring, for FLEX Options expiring on Expiration Friday, the 
aggregation of all position and exercise limits with Non-FLEX Options 
on the same underlying index or security, requiring fungible FLEX and 
Non-FLEX Options in the same series to trade only pursuant to Non-FLEX 
trading rules, and maintaining heightened reporting requirements for 
large FLEX Options positions. The Commission believes that with these 
safeguards in place the Exchange's proposal to eliminate the current 
restrictions on Flex Option expirations on and around Expiration Friday 
should be approved.
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    \21\ The Commission notes that in Amendment No. 2 the Exchange 
modified its proposal to prohibit average pricing formulas as well 
as p.m. settlements during the Blackout Periods. As CBOE notes, 
average pricing may not raise similar concerns as p.m. settlement. 
However, because average pricing settlement is only permitted 
pursuant to parameters set by the CBOE, and to date it appears that 
it has not set such parameters (except for SPX), it is appropriate 
to have CBOE do so before such average pricing settlement is 
permitted around or on Expiration Friday. We would expect the 
Exchange to file a proposed rule change pursuant to Section 19(b) 
under the Act relating to such parameters.
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    As previously noted by the Commission, the CBOE's FLEX market was 
created to address the needs of sophisticated portfolio managers and 
other institutional investors who are increasingly using the OTC market 
to meet their investment needs. The Commission believes that CBOE's 
proposal to expand the eligible expiration dates for FLEX Options 
should give market participants greater flexibility in determining 
whether to execute their customized options in an exchange environment 
or in the OTC market.
    The Commission believes that the CBOE proposal should help to 
promote the maintenance of a fair and orderly market consistent with 
the requirements of Section 6(b)(5) of the Act \22\ by extending the 
benefits of a listed, exchange market to additional FLEX Options. These 
benefits include, but are not limited to, a centralized market center, 
an auction market with posted transparent market quotations and 
transaction reporting, standardized parameters and procedures for 
clearance and settlement, and heightened contra-party creditworthiness 
due to the role of The Options Clearing Corporation (``OCC'') as issuer 
and guarantor of FLEX Options. Moreover, to the extent there may be a 
risk of adverse market effects attributable to options that would 
otherwise be traded in a non-transparent fashion in the OTC market, the 
Commission agrees with CBOE that such risks could be lessened by making 
these customized options eligible for trading in an exchange 
environment because of the added transparency, price discovery, and 
potential liquidity.
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    \22\ 15 U.S.C. 78f(b)(5).
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    Because of the elimination of Blackout Periods surrounding 
Expiration Fridays, the Commission recognizes that the proposal will 
result, for the first time, in the possibility that FLEX Options 
positions may be established in Non-FLEX series. The Commission would 
be concerned if the FLEX Options could act as a surrogate for trading 
in standardized options, especially since the standardized options 
market contains certain protections for investors. This is of 
particular concern because the Commission recognizes that the FLEX 
Options market is designed to contain the benefits of an auction market 
with the features of negotiated transactions, and therefore continuous 
quotes may not always be available. However, the rules, as proposed by 
the CBOE, help to ensure that FLEX market participants cannot avoid the 
protections provided to retail investors in the standardized options 
market simply by trading FLEX Options. In this regard, once a series is 
open for trading, new FLEX Options are not permitted in that series. In 
addition, once a Non-FLEX Options series is open, all outstanding FLEX 
Options in the same series become fungible with the standardized 
market, are traded pursuant to standardized market trading rules, and 
are aggregated for position and exercise limit purposes. These rules 
help to alleviate these surrogate concerns and should help to ensure 
that FLEX Options market continues to operate as intended.
    Finally, the Commission expects the CBOE to report any undue 
effects that may occur due to the elimination of the Blackout Period. 
This includes taking any prompt action should any unanticipated 
consequences develop.
    The Commission finds good cause, pursuant to Section 19(b)(2) of 
the Act,\23\ for approving the proposal, as modified by Amendments No. 
1 and 2, prior to the thirtieth day after the date of publication of 
notice of filing of Amendments No. 1 and 2 in the Federal Register.\24\
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    \23\ 15 U.S.C. 78s(b)(2).
    \24\ Pursuant to Section 19(b)(2) of the Act, 15 U.S.C. 
78s(b)(2), the Commission may not approve any proposed rule change, 
or amendment thereto, prior to the thirtieth day after the date of 
publication of the notice thereof, unless the Commission finds good 
cause for so doing.
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    In Amendment No. 1, the Exchange proposed to clarify the applicable 
exercise limits for FLEX Options that expire on an Expiration Friday. 
Specifically, the Exchange proposed that such FLEX Options shall be 
aggregated with positions in comparable Non-FLEX Options and shall be 
subject to the exercise limits set forth in Rule 4.12 (which pertains 
to exercise limits for Non-FLEX Equity Options), 24.5 (which pertains 
to exercise limits for Non-FLEX Index Options), or 29.7 (which pertains 
to exercise limits for Non-FLEX Credit Options), as applicable. The 
Commission believes that aggregating FLEX options that expire on a 
third Friday-of-the-month expiration day with comparable Non-FLEX 
Options and applying the Non-FLEX Options exercise limits is consistent 
with the manner in which the Exchange proposed to aggregate and apply 
position limits for such FLEX Options and comparable Non-FLEX Options 
and should provide additional safeguards to reduce any risk of adverse 
market effects that might occur as a result of large FLEX exercises in 
FLEX Option series that expire near Non-FLEX expirations.
    In Amendment No. 2, the Exchange proposed to further revise 
proposed Rules 24A.4 and 24B.4 to include an additional restriction 
that FLEX Index Options that have expiration dates that fall within the 
Blackout Period may not have an exercise settlement value based on a 
specified average. Thus, as revised, the proposed rule would require 
that FLEX Index Options expiring within the Blackout Period only have 
an a.m. exercise settlement value.\25\
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    \25\ Currently, FLEX Index Options that expire on any day 
outside the old blackout period can have an exercise settlement 
value determined by reference to one of three values: (i) An a.m. 
exercise settlement value; (ii) a p.m. exercise settlement value; or 
(iii) an average index value, provided that it conforms to the 
averaging parameters, if any, established by the Exchange. The 
Exchange originally proposed that FLEX Index Options that have 
expiration dates that fall within the Blackout Period may not have a 
p.m. exercise settlement value.
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    The limitation on exercise settlement value calculations proposed 
in Amendment No. 2 is intended to serve as an additional safeguard 
against potential adverse effects that might be associated with triple 
witching and p.m.

[[Page 8594]]

settlements.\26\ Because CBOE, for the most part, has not set any 
average pricing parameters, the Commission is unclear what the 
potential market impact could be on or around Expiration Friday. 
Therefore, it is reasonable and consistent with Section 6(b)(5) of the 
Act \27\ for CBOE to restrict average pricing during the Blackout 
Period until it sets forth a specific proposal and the potential market 
impact can be adequately addressed.\28\
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    \26\ The expiration of the contracts for stock index futures, 
stock index options, and stock options all expire on the same days 
occurring on the third Friday of March, June, September, and 
December (which is referred to as ``triple witching''). The 
Exchange's proposed limitations on p.m. exercise settlement values 
and exercise settlement values based on a specified average would 
apply during triple witching expirations, as well as on all other 
Expiration Fridays.
    \27\ 15 U.S.C. 78f(b)(5).
    \28\ See supra note 21.
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    Based on the above, the Commission finds good cause for approving 
the CBOE's proposal, as modified by Amendments No. 1 and 2, on an 
accelerated basis, pursuant to Section 19(b)(2) of the Act.

V. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning Amendments No. 1 and 2 to File No. SR-CBOE-2008-
115, including whether Amendments No. 1 and 2 are 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 protected]. Please include 
File Number SR-CBOE-2008-115 on the subject line.

Paper Comments

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

All submissions should refer to File Number SR-CBOE-2008-115. 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 Amex. All comments received will be 
posted without change; the Commission does not edit personal 
identifying information from submissions. You should submit only 
information that you wish to make available publicly. All submissions 
should refer to File Number SR-CBOE-2008-115 and should be submitted on 
or before March 18, 2009.

VI. Conclusion

    For the foregoing reasons, the Commission finds that the proposed 
rule changes are consistent with the Act and the rules and regulations 
thereunder applicable to a national securities exchange.
    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\29\ that the proposed rule change (SR-CBOE-2008-115), as modified 
by Amendments No. 1 and 2 thereto, be and hereby is approved on an 
accelerated basis.
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    \29\ 15 U.S.C. 78s(b)(2).
    \30\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\30\
Florence E. Harmon,
Deputy Secretary.
 [FR Doc. E9-4036 Filed 2-24-09; 8:45 am]
BILLING CODE 8011-01-P