
[Federal Register: February 25, 2008 (Volume 73, Number 37)]
[Notices]               
[Page 10076-10080]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr25fe08-130]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-57352; File No. SR-CBOE-2008-07]

 
Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Notice of Filing and Order Granting Accelerated Approval 
of Proposed Rule Change, as Modified by Amendment No. 1, Requesting 
Permanent Approval of Two Pilot Programs That Increase Position and 
Exercise Limits

February 19, 2008.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on February 6, 2008, the Chicago Board Options Exchange, Incorporated 
(``CBOE'' or ``Exchange'') filed with the Securities and Exchange 
Commission (``Commission'') the proposed rule change as described in 
Items I and II below, which Items have been substantially prepared by 
the Exchange. The Exchange filed Amendment No. 1 to the proposed rule 
change on February 13, 2008. This order provides notice of the proposed 
rule change as modified by Amendment No. 1 and approves the proposed 
rule change as amended on an accelerated basis.

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

    The Exchange requests permanent approval of two pilot programs that 
increase position and exercise limits for equity options. The Exchange 
proposes to amend Rule 4.11, Position Limits, and Rule 4.12, Exercise 
Limits, to permanently establish the increased limits of the two pilot 
programs. The text of the proposed rule change is available at CBOE, 
the Commission's Public Reference Room, and http://www.cboe.org/legal.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19-4.
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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 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 III 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 purpose of the proposed rule change is to request permanent 
approval of two pilot programs that increase position and exercise 
limits for equity options. The Exchange proposes to amend Rule 4.11, 
Position Limits, and Rule 4.12, Exercise Limits, to permanently 
establish the increased limits of the two pilot programs. Rule 4.11 
subjects equity options to one of

[[Page 10077]]

five different position limits depending on the trading volume and 
outstanding shares of the underlying security. Rule 4.12 establishes 
exercise limits for equity options at the same levels as the applicable 
position limits.\3\
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    \3\ Rule 4.12 states, ``no member shall exercise, for any 
account in which it has an interest or for the account of any 
customer, a long position in any option contract where such member 
or customer, acting alone or in concert with others, directly or 
indirectly, * * * has or will have exercised within any five 
consecutive business days aggregate long positions in any class of 
options dealth in on the Exchange in excess'' of the established 
limits set by the Exchange.
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    The first pilot program, the ``Rule 4.11 Pilot Program,'' commenced 
on February 23, 2005, and provides for an increase to the standard (or 
``non-pilot'') position and exercise limits for equity option contracts 
and for options on the PowerShares QQQ Trust (``QQQQ'').\4\ 
Specifically, the Rule 4.11 Pilot Program increases the applicable 
position and exercise limits for equity options and QQQQ options as 
follows:
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    \4\ The Rule 4.11 Pilot Program was approved by the Commission 
on February 23, 2005. See Securities Exchange Act Release No. 51244 
(February 23, 2005), 70 FR 10010 (March 1, 2005) (order approving 
SR-CBOE-2003-30, as amended) (``Pilot Program Order''). The Rule 
4.11 Pilot Program has been extended 5 times for 6 month periods by 
the Commission, and expires on March 1, 2008. See Securities 
Exchange Act Release No. 52262 (August 15, 2005), 70 FR 48995 
(August 22, 2005) (SR-CBOE-2005-61), Securities Exchange Act Release 
No. 53348 (February 22, 2006), 71 FR 10574 (March 1, 2006) (SR-CBOE-
2006-11), Securities Exchange Act Release No. 54336 (August 18, 
2006), 71 FR 50952 (August 28, 2006) (SR-CBOE-2006-69), Securities 
Exchange Act Release No. 55266 (February 9, 2007), 72 FR 7698 
(February 16, 2007) (SR-CBOE-2007-12), and Securities Exchange Act 
Release No. 56266 (August 15, 2007), 72 FR 47094 (August 22, 2007) 
(SR-CBOE-2007-97).
    In connection with the March 21, 2007 transfer of sponsorship of 
the Nasdaq-100 Trust, the name of the trust was changed to the 
``PowerShares QQQ Trust.'' See QQQQ prospectus available at http://
www.powershares.com/pdf/P-QQQ-PRO-1.pdf.

------------------------------------------------------------------------
  Standard equity option contract        Pilot Program equity option
               limit                            contract limit
------------------------------------------------------------------------
                         13,500                               25,000
                         22,500                               50,000
                         31,500                               75,000
                         60,000                              200,000
                         75,000                              250,000
------------------------------------------------------------------------
Standard QQQQ option contract limit  Pilot Program QQQQ option contract
                                                               limit
------------------------------------------------------------------------
                    \5\ 300,000                              900,000
------------------------------------------------------------------------

    The \5\ second pilot program, the ``iShares Russell 2000 Index Fund 
(`IWM') Option Pilot Program,'' commenced on January 22, 2007, and 
increases the position and exercise limits for IWM options from 250,000 
contracts to 500,000 contracts.\6\
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    \5\ The standard position and exercise limits for QQQQ options 
are 300,000 contracts. See Securities Exchange Act Release No. 45309 
(January 18, 2002), 67 FR 3757 (January 25, 2002) (SR-CBOE-2001-44). 
The standard position and exercise limits for options on DIA and SPY 
are also 300,000 contracts. See Securities Exchange Act Releases 
Nos. 47346 (February 11, 2003), 68 FR 8316 (February 20, 2003) (SR-
CBOE-2002-26), 51041 (January 14, 2005), 70 FR 3408 (January 24, 
2005) (SR-CBOE-2005-06).
    \6\ The IWM Option Pilot Program doubles the position and 
exercise limits for IWM options under the Rule 4.11 Pilot Program. 
Absent both of these pilot programs, the standard position and 
exercise limit for IWM options is 75,000 option contracts.
    The proposal that established the IWM Option Pilot Program was 
designated by the Commission to be effective and operative upon 
filing. See Securities Exchange Act Release No. 55176 (January 25, 
2007), 72 FR 4741 (February 1, 2007) (SR-CBOE-2007-08). The IWM 
Option Pilot Program has been extended twice by the Commission and 
expires on March 1, 2008. See Securities Exchange Act Release No. 
55926 (June 20, 2007), 72 FR 35275 (June 27, 2007) (SR-CBOE-2007-
61); Securities Exchange Act Release No. 57141, 73 FR 3496 (January 
18, 2008) (SR-CBOE-2007-147).
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a. Standard Position and Exercise Limits
    The standard position limits were last increased nine years ago, on 
December 31, 1998.\7\ Since that time, there has been a steady increase 
in the number of accounts that: (a) Approach the position limit; (b) 
exceed the position limits; and (c) are granted an exemption to the 
applicable position limit. To illustrate CBOE's position on this 
matter, CBOE's Division of Market Regulation conducted a review of four 
incident categories involving position limits: (i) Violations; (ii) 
accounts near 10% of pilots' position limits; (iii) account positions 
and pilots' limits vs. standard limits; and (iv) exemptions granted.
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    \7\ See Securities Exchange Act Release No. 40875 (December 31, 
1998), 64 FR 1842 (January 12, 1999) (SR-CBOE-98-25).
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(i) Violations
    During the period of January 1, 2007 through January 1, 2008, when 
both pilot programs were in effect, the Exchange opened a total of 19 
reviews regarding equity option position and exercise limits at the 
pilot levels, which led to findings of 7 violations. To the best of the 
staff's knowledge, all of these violations were deemed inadvertent--due 
primarily to miscounting, technical problems, or a misinterpretation of 
position limit calculation methodologies. None of these violations were 
deemed to be a result of manipulative activities.
(ii) Accounts Near 10% of Pilots' Position Limits
    The Exchange utilizes a heightened surveillance technique to 
identify different types of accounts that are within 10% of the pilot 
position limit tiers. As of December 20, 2007, Exchange staff 
identified 36 accounts that were within 10% of the pilot position limit 
tiers. As illustrated below, the majority of the accounts were firm/
market-maker accounts involving the 250,000 contract pilot position 
limit tier. The Exchange believes that members and large customers 
(e.g., mutual funds, hedge funds, and pension funds) are utilizing the 
higher limits in their portfolios and transactions with the confidence 
that they will not exceed the limits.

----------------------------------------------------------------------------------------------------------------
                                                                                                LOPR/aggregated
        Pilot position limit tier            LOPR \8\ 10%     Firm/market-     LOPR 10% in     open interest 10%
                                                               maker 10%         concert              \9\
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25,000...................................                0                0                0                   1
50,000...................................                0                0                0                   0
75,000...................................                1                0                0                   0
250,000..................................                6               10                0                   4
300,000..................................                1                7                1                   1
500,000..................................                0                1                0                   0

[[Page 10078]]


900,000..................................                0                3                0                   0
                                          ----------------------------------------------------------------------
    Total Accts..........................                8               21                1                   6
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(iii) Account Positions and Pilots' Limits vs. Standard Limits
    Exchange staff examined approximately 160 member/firm accounts and 
approximately 754 customer accounts, as of December 2007, and compared 
the current contract quantities to: (a) the Rule 4.11 and IWM Option 
Pilot Programs' position limits; and (b) the standard equity position 
limits. Without the increased position limits provided for by the Rule 
4.11 and IWM Option Pilot Programs, virtually all of the customer 
accounts would be in violation of the standard position limits. The 
same, however, cannot be said of the member/firm accounts, as those 
accounts may utilize exemptions not available to customers. As a 
result, a significant amount of customers would be disadvantaged if the 
pilot programs' position limits levels are not made permanent.
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    \8\ Large Options Position Report (``LOPR'').
    \9\ The LOPR/Aggregated Open Interest 10% report aggregates 
positions of affiliated accounts (i.e., those that clear in the 
customer range with those that clear in the firm proprietary and/or 
market-maker range), and reflects same side of the market positions 
that are within 10% of the applicable pilot position limit tiers.
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(iv) Exemptions
    Exchange staff examined position limit exemptions to the pilot 
position limit tiers as of December 20, 2007, and observed that among 
the various options exchanges, 53 exemptions to positions limits under 
the pilot position limit tiers were granted in equity option classes, 
the majority of which occurred in the 250,000 and 300,000 pilot tier 
levels.\10\ In addition, seven exemptions to the position limit pilot 
tier of 500,000 contracts were granted in the IWM options class, which 
has a standard position limit of 75,000 contracts.
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    \10\ As to the 53 exemptions, the majority were granted prior to 
December 2007 and subsequently renewed.
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b. Growth in Options Market
    Since the last position limit increase, there has been an 
exponential increase in the overall volume of exchange traded options. 
The below chart demonstrates the growth in options trading industry-
wide between 1999 and 2007.

------------------------------------------------------------------------
                                       Annual industry options trading
               Year                                volume
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1999..............................  508,000,000 contracts.
2000..............................  727,000,000 contracts.
2001..............................  782,000,000 contracts.
2002..............................  780,000,000 contracts.
2003..............................  908,000,000 contracts.
2004..............................  1,182,000,000 contracts.
2005..............................  1,504,000,000 contracts.
2006..............................  2,028,000,000 contracts.
2007..............................  2,863,000,000 contracts.
------------------------------------------------------------------------

    Part of this volume is attributable to a corresponding increase in 
the number of overall market participants. This growth in market 
participants has in turn brought about additional depth and increased 
liquidity in exchange traded options.
c. Manipulation
    Since the last position limit increase, and throughout the duration 
of the two pilot programs, the Exchange has not encountered any 
regulatory issues regarding the applicable position limits, and states 
there is a lack of evidence of market manipulation schemes, which 
justifies the proposed permanent approval of the Rule 4.11 and IWM 
Option Pilot Programs.
    The Exchange believes that position and exercise limits, at the 
non-pilot levels, no longer serve their stated purpose. The Commission 
has previously stated:

    Since the inception of standardized options trading, the options 
exchanges have had rules imposing limits on the aggregate number of 
options contracts that a member or customer could hold or exercise. 
These rules are intended to prevent the establishment of options 
positions that can be used or might create incentives to manipulate 
or disrupt the underlying market so as to benefit the options 
position. In particular, position and exercise limits are designed 
to minimize the potential for mini-manipulations and for corners or 
squeezes of the underlying market. In addition, such limits serve to 
reduce the possibility for disruption of the options market itself, 
especially in illiquid options classes.\11\
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    \11\ See Securities Exchange Act Release No. 39489 (December 24, 
1997), 63 FR 276 (January 5, 1998) (SR-CBOE-97-11).

    As the anniversary of listed options trading approaches its 35th 
year, the Exchange believes that the existing surveillance procedures 
and reporting requirements at CBOE, at other options exchanges, and at 
the several clearing firms are capable of properly identifying unusual 
and/or illegal trading activity. In addition, routine oversight 
inspections of CBOE's regulatory programs by the Commission have not 
uncovered any material inconsistencies or shortcomings in the manner in 
which the Exchange's market surveillance is conducted relating to 
position and exercise limits. These procedures include daily monitoring 
of market movements via automated surveillance techniques to identify 
unusual activities in both options and underlying stocks and Exchange 
Traded Funds (``ETFs'').
    Furthermore, large stock holdings must be disclosed to the 
Commission by way of Schedules 13D and 13G. Options positions are part 
of any reportable positions, and thus cannot be legally hidden. The 
Exchange also requires that member organizations file reports with the 
Exchange for any customer who holds aggregate long or short positions 
on the same side of the market of 200 or more option contracts of any 
single class for the previous day.\12\ In addition, the Exchange 
requires that firms and market-makers report their positions, and the 
Exchange has access, via The Options Clearing Corporation (``OCC''), to 
daily data with respect to these options positions. Finally, in 
granting firms' requests for exemptions or disaggregation within firm 
positions, CBOE and the other options markets require enhanced 
reporting-either directly to the granting exchange or through LOPR, as 
applicable. In sum, these reporting requirements will continue to serve 
as an important part of the Exchange's surveillance efforts.
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    \12\ See Rule 4.13(a).
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    Accordingly, the Exchange represents that its surveillance 
procedures (which have been significantly enhanced since the last 
position limit increase) and reporting procedures, in conjunction with 
the financial requirements and risk management review procedures 
already in place at the clearing firms and the OCC, will serve to 
adequately address any concerns the Commission may have with respect to 
account(s) engaging in any manipulative schemes or assuming too high a 
level of risk exposure.
d. Financial Requirements
    The Exchange believes that the current financial requirements 
imposed

[[Page 10079]]

by the Exchange and by the Commission adequately address concerns that 
a member or its customer may try to maintain an inordinately large 
unhedged position in an equity option. Current margin and risk-based 
haircut methodologies serve to limit the size of positions maintained 
by one account by increasing margin and/or capital that a member must 
maintain for a large position held by itself or by its customer. The 
Exchange also notes that it has the authority under Rule 12.3(h) and 
Rule 12.10 to impose higher margin requirements upon a member or member 
organization when the Exchange determines that higher requirements are 
required. Also, the Commission's net capital rule imposes a capital 
charge on members to the extent any margin deficiency results from the 
higher margin requirement.\13\
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    \13\ See 17 CFR 240.15c3-1.
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e. Inability To Compete; Retreat to OTC Market
    The Exchange has no reason to believe that the current trading 
volume in equity options will not continue. Rather, the Exchange 
expects continued options volume growth as opportunities for investors 
to participate in the options markets increase and evolve. The Exchange 
believes that the non-pilot position and exercise limits are 
restrictive, and returning to those limits will hamper fair and 
effective competition between the listed options markets and the over-
the-counter (``OTC'') markets. In fact, the Commission highlighted 
competition with the OTC markets as a reason for increasing the 
standard position and exercise limits in 1998.\14\ Specifically, the 
Commission stated:
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    \14\ See Securities Exchange Act Release No. 40875 (December 31, 
1998), 64 FR 1842 (January 12, 1999) (SR-CBOE-98-25).

    The increase in position and exercise limits for standardized 
equity options should allow the Exchanges to better compete with the 
growing OTC market in customized equity options, thereby encouraging 
fair competition among brokers and exchange markets.\15\
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    \15\ Id.

    In addition, the Exchange believes that without permanently 
establishing the position and exercise limits set forth in the pilot 
programs, large customers, such as mutual funds, hedge funds and 
pension funds, will find the standard equity position limits an 
impediment to their business and investment objectives. As such, market 
participants may find the less-transparent OTC markets a more 
attractive alternative to achieve their investment and hedging 
objectives, leading to a retreat from the listed options markets, where 
trades are subject to reporting requirements and daily surveillance.
f. No Adverse Consequences From Past Increases
    Equity option position limits have been gradually expanded from 
1,000 contracts in 1973 to the current level of 75,000 contracts for 
the largest and most actively traded equity options. To date, there 
have been no adverse affects on the markets as a result of these past 
increases in the limits for equity option contracts.
2. Statutory Basis
    The Exchange believes that the proposed rule change is consistent 
with the requirements provided under Section 6(b)(5) of the Act,\16\ 
which state in part that the rules of an exchange must be designed to 
promote just and equitable principles of trade, to prevent fraudulent 
and manipulative acts, and, in general, to protect investors and the 
public interest.
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    \16\ 15 U.S.C. 78f(b)(5).
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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

    The Exchange neither solicited nor received comments on the 
proposal.

III. 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 rule-comments@sec.gov. Please include 
File Number SR-CBOE-2008-07 on the subject line.

Paper Comments

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

All submissions should refer to File Number SR-CBOE-2008-07. 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 offices 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 available publicly. All 
submissions should refer to File Number SR-CBOE-2008-07 and should be 
submitted on or before March 17, 2008.

IV. Commission's Findings and Order Granting Accelerated Approval of 
the Proposed Rule Change

    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.\17\ In particular, the Commission finds that the proposed 
rule change is consistent with Section 6(b)(5) of the Act \18\ in that 
it is designed to prevent fraudulent and manipulative acts and 
practices, to promote just and equitable principles of trade, to remove 
impediments to and perfect the mechanism of a free and open market and 
a national market system, and, in general, to protect investors and the 
public interest.
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    \17\ In approving this proposed rule change, the Commission 
notes that it has considered the proposed rule's impact on 
efficiency, competition, and capital formation. See 15 U.S.C. 
78c(f).
    \18\ 15 U.S.C. 78f(b)(5).
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    The Commission believes that the proposal to permanently establish 
the increased position and exercise limits of the Rule 4.11 Pilot 
Program and the

[[Page 10080]]

IWM Option Pilot Program is consistent with the Act. As the Commission 
previously has noted, rules regarding position and exercise limits are 
intended to prevent the establishment of options positions that can be 
used or might create incentives to manipulate or disrupt the underlying 
market so as to benefit the options position. In particular, position 
and exercise limits are designed to minimize the potential for mini-
manipulations and for corners or squeezes of the underlying market. In 
addition, such limits serve to reduce the possibility for disruption of 
the options market itself, especially in illiquid options classes.\19\
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    \19\ See Securities Exchange Act Release No. 39489, supra note 
11.
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    The Exchange has represented that, over the recent history of 
steadily increasing position and exercise limits, it has detected no 
adverse consequences and has received no complaints relating to their 
position and exercise limits or the Rule 4.11 and IWM Option Pilot 
Programs. According to the Exchange, it has not encountered any 
regulatory issues regarding the position limits subject to the two 
pilot programs or any instances of manipulation. Moreover, the Exchange 
pointed to the very significant increase in the overall volume of 
exchange-traded options since 1999. This growth in trading volume and 
number of market participants has brought additional depth and 
increased liquidity in exchange-traded options and thereby has lessened 
concerns about the potential for disruptions in the options markets 
that may occur through increased position and exercise limits.
    The Commission expects the Exchange to continue to monitor for 
violations of the position and exercise limits with the purpose of 
discovering and sanctioning fraudulent or manipulative acts and 
practices, and to reassess the position and exercise limits, if and 
when appropriate, in light of its findings. Finally, the Commission 
notes that in approving the proposed rule change, it has relied upon 
the Exchange's representation that its surveillance procedures and 
reporting requirements, discussed above, will continue to monitor for 
manipulative schemes or too high a level of risk exposure.
    In light of the foregoing, the Commission believes that the current 
position and exercise limits under the two pilot programs represent an 
appropriate balance between the Exchange's desire to accommodate market 
participants by offering higher position and exercise limits, 
particularly in light of the marked increase in the volume of exchange-
traded options in recent years, and the need to provide checks on 
potential market manipulation, imprudent assumption of risk (e.g., 
entering into large unhedged positions), and other potential trading 
abuses.
    The Commission finds good cause for approving the proposed rule 
change before the 30th day after the date of publication of notice of 
filing in the Federal Register. The Commission notes that the Rule 4.11 
Pilot Program and the IWM Option Pilot Program both expire on March 1, 
2008. The Commission believes accelerated approval of the proposed rule 
change is appropriate in order to maintain uninterrupted position and 
exercise limit levels.

V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\20\ that the proposed rule change (SR-CBOE-2008-07), as modified 
by Amendment No. 1, be, and it hereby is, approved on an accelerated 
basis.
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    \20\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\21\
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    \21\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. E8-3432 Filed 2-22-08; 8:45 am]

BILLING CODE 8011-01-P
