
[Federal Register: March 4, 2008 (Volume 73, Number 43)]
[Notices]               
[Page 11689-11692]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr04mr08-111]                         


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-57376; File No. SR-CBOE-2007-104]

 
Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Order Approving Proposed Rule Change, as Modified by 
Amendment No. 1 Thereto, To List and Trade Range Options and 
Designating Range Options as Standardized Options Pursuant to Rule 9b-1 
of the Exchange Act

February 25, 2008.

I. Introduction

    On September 6, 2007, the 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 list and trade range options. 
CBOE filed Amendment No. 1 to the proposal on December 3, 2007.\3\ The 
proposed rule change, as modified by Amendment No. 1, was published for 
comment in the Federal Register on December 28, 2007.\4\ The Commission 
received no comment letters regarding the proposed rule change. This 
order approves the proposed rule change, as modified by Amendment No. 1 
and designates Range Options as standardized options pursuant to Rule 
9b-1 of the Act.
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    \1\15 U.S.C. 78s(b)(1).
    \2\17 CFR 240.19b-4.
    \3\Amendment No. 1 replaced the original filing in its entirety. 
The purpose of Amendment No. 1 was to: (i) Revise the proposed 
changes to CBOE Rule 12.3, Margin Requirements, to specify initial 
and/or maintenance margin requirements for margin and cash accounts 
and to conform the proposed rule text to existing rule text for 
other products; (ii) revise the proposed definitions of ``Range 
Interval,'' ``Low Range and Low Range Exercise Value,'' ``High Range 
and High Range Exercise Value,'' ``Exercise Settlement Amount,'' and 
to add a new proposed definition of ``exercise price;'' (iii) revise 
proposed CBOE Rule 20.3 to state specifically that Range Options are 
a separate class from other options overlying the same index; (iv) 
revise proposed CBOE Rules 20.6, Position Limits, and 20.7, Reports 
Related Position Limits and Liquidation of Positions, to provide 
that Range Options will be aggregated with other option contracts on 
the same underlying index, including other classes of Range Options 
overlying the same index, for position limit purposes; (v) revise 
proposed CBOE Rule 20.11 to reference certain rules of The Options 
Clearing Corporation (``OCC''); (vi) add new proposed CBOE Rule 
20.12 to provide that, for purposes of Range Options, reference in 
the Exchange Rules to the ``appropriate committee'' shall be read to 
be the ``Exchange;'' (vii) provide additional information regarding 
FLEX options; (viii) delete footnote 2 from the original proposed 
rule change, because the proposal referenced therein, SR-CBOE-2006-
99, is now effective (See Securities Exchange Act Release No. 56792 
(November 15, 2007), 72 FR 65776 (November 23, 2007)); and (ix) make 
conforming changes, clarifications and corrections in the 
``Purpose'' section of the filing.
    \4\See Securities Exchange Act Release No. 56993 (December 19, 
2007), 72 FR 73913.
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II. Description of the Proposal

    CBOE proposes to list and trade cash-settled, European-style Range 
Options that overlie any index eligible for options trading on the 
Exchange. Range Options will have a positive payout if the settlement 
value of the underlying index falls within the specified Range Length 
at expiration. Range Options will be based on the same framework as 
existing options that are traded on the Exchange. However, the maximum 
payout amount will be capped (as specified by the Exchange at listing) 
and the specific exercise settlement amount may vary based on where on 
the Range Length the settlement value of the underlying index value 
falls.

The Payout Structure of Range Options

    The universe of possible payout amounts for Range Options resembles 
the shape of an isosceles trapezoid spread over a range of index values 
or the ``Range Length.'' The Range Length, or the bottom parallel (and 
longer) line of the trapezoid, defines the entire length of index 
values for which the option pays a positive amount if the settlement 
value of the underlying index falls within the specific Range Length. 
In other words, the Range Length equals the total span between two 
underlying index values, as set by the Exchange at listing, that is 
used to determine whether a Range Option is in or out of the money at 
expiration.
    The Range Length is comprised of three segments that are defined by 
the ``Range Interval,'' which is a value that the Exchange will specify 
at listing and the minimum Range Interval will be at least 5 index 
points. Using the isosceles trapezoid diagram below, the ``Range 
Interval,'' defines congruent triangles on opposite sides of the 
trapezoid, which have base angles of equal degrees and equal base 
lengths.
    The first triangle at the start of the Range Length defines the 
``Low Range'' for the Range Option and if the settlement value of the 
underlying index value falls in the Low Range (the ``Low Range Exercise 
Value''), the option will pay an amount that increases as the index 
value increases within the Low Range. To determine the exercise 
settlement amount if the settlement value of the index falls within the 
Low Range, the Low Range Exercise Value will be multiplied by the 
contract multiplier, set by the Exchange at listing.
    The second triangle at the end of the Range Length defines the 
``High Range'' for the Range Option and if the settlement value of the 
underlying index falls in the High Range, the option will pay an amount 
that decreases as the index value increases within the High Range 
(``High Range Exercise Value''). To determine the exercise settlement 
amount if the settlement value of index falls within the High Range, 
the High Range Exercise Value will be multiplied by the contract 
multiplier, set by the Exchange at listing. Lastly, the Low Range and 
High Range are segments of equal lengths at opposite ends on the Range 
Length and if the settlement value of the underlying index falls at the 
starting value of the Low Range, at the ending value of the High Range 
or outside of either the Low Range or the High Range, the option will 
pay $0.

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[GRAPHIC] [TIFF OMITTED] TN04MR08.012

    The third segment of the Range Option is defined as the ``Middle 
Range,'' and its length is equal to the Range Length minus twice the 
Range Interval, or as illustrated in the above diagram, its length is 
equal to the length of the top parallel (and shorter) line of the 
trapezoid. If the settlement value of the underlying index falls 
anywhere within the Middle Range at expiration, the payout is a fixed 
amount (set by the Exchange at listing) and does not vary depending on 
where in the Middle Range the index value falls. Also, if the index 
value falls in the Middle Range, this will be the highest amount that 
can be paid out for a Range Option and is defined as the ``Maximum 
Range Exercise Value.'' To determine the exercise settlement amount if 
the settlement value of the index falls anywhere within the Middle 
Range, the Maximum Range Exercise Value will be multiplied by the 
contract multiplier, set by the Exchange at listing.
    Unlike other options, Range Options will only be of a single type, 
and there will not be traditional calls and puts. Also, the exercise or 
``strike'' price for Range Options will be the Range Length that, akin 
to a regular strike price, will be used to determine if the Range 
Option is in or out of the money. When applicable, the ``strike price'' 
for a Range Option (i.e., the Range Length) will be used to determine 
the degree that the option is in-the-money (capped at the Maximum Range 
Exercise Value) if the settlement value of the underlying index falls 
within either the High or Low Range of the Range Length.

Benefits of Range Options

    The Exchange believes that the introduction of Range Options will 
provide advantages to the investing public that are not provided for by 
other index options. First, the Exchange believes that Range Options 
offer investors a relatively low risk security where the risk reduction 
results from knowing the maximum risk exposure when the contract is 
written. While there may be variations in the exercise settlement 
amount, the maximum exercise settlement amount is set at listing and 
the maximum risk therefore is limited and known at listing. Second, 
Range Options are structured similar to two-sided European-style binary 
options that provide additional flexibility because the option pays a 
reduced amount if the underlying index settles outside the main range 
covered by the option.

Proposed New Rules

    To accommodate the introduction of Range Options, the Exchange 
proposes to adopt new Chapter XX to its rules and to make amendments to 
existing CBOE Rules 6.1, Days and Hours of Business, and 12.3, Margin 
Requirements. An introductory paragraph to Chapter XX will explain that 
the proposed rules in the proposed Chapter are applicable only to Range 
Options. Trading in Range Options also will be subject to the rules in 
Chapter I through XIX, XXIV, XXIVA and XXIVB, in some cases 
supplemented by the proposed rules in the Chapter, except for existing 
rules that will be replaced by the proposed rules in the Chapter and 
except where the context otherwise requires. As proposed, the majority 
of the rules governing index options will equally apply to Range 
Options. Those new proposed rules and those proposed amendments to 
existing rules pertaining to Range Options are described below.
(a) Definitions (CBOE Rule 20.1)
    New Chapter XX, Range Option Contracts, includes new definitions 
applicable to Range Options in CBOE Rule 20.1. In particular, the terms 
``Range Option,'' ``settlement value,'' ``Range Length,'' ``Range 
Interval,'' ``Low Range and Low Range Exercise Value,'' ``High Range 
and High Range Exercise Value,'' ``Middle Range and Maximum Range 
Exercise Value,'' ``contract multiplier,'' ``exercise settlement 
amount,'' and ``exercise price'' will be defined.
(b) Days and Hours of Business (CBOE Rule 20.2 and Amendment to CBOE 
Rule 6.1)
    CBOE Rule 20.2 and an amendment to CBOE Rule 6.1, Days and Hours of 
Business Days and Hours of Business, provides that transactions in 
Range Options may be effected during normal Exchange option trading 
hours for other options on the same index.
(c) Designation of Range Option Contracts and Maintenance Listing 
Standards (CBOE Rules 20.3 and 20.4)
    CBOE Rule 20.3 provides that the Exchange may from time to time 
approve for listing and trading on the Exchange Range Option contracts 
that overlie any index that is eligible for options trading on the 
Exchange. Range Options will be a separate class from other options 
overlying the same index. The Exchange may add new series of Range 
Options of the same class (i.e., overlying the same index) as provided 
for by the rules governing options on the same underlying index. 
Additional series of Range Options may be opened for trading on the 
Exchange when the Exchange deems it necessary to maintain an orderly 
market or to meet customer demand. The opening of a new series of Range 
Options on the Exchange will not affect any other series of options of 
the same class previously opened.
    CBOE Rule 20.4 provides that the maintenance listing standards with 
respect to options on indexes set forth in CBOE Rule 24.2 and the 
Interpretations and Policies thereunder will be applicable to Range 
Options on indexes. CBOE Rule 24.2, Designation of the Index, sets 
forth initial and maintenance listing criteria for index options.
(d) Limitation of Liability of Exchange and of Reporting Authority 
(CBOE Rule 20.5)
    CBOE Rule 20.5 provides that CBOE Rule 6.7, Exchange Liability, 
will be applicable in respect of any class of Range Options and that 
CBOE Rule

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24.14, Disclaimers, will be applicable in respect of any reporting 
authority that is the source of values of any index underlying any 
class of Range Options.
(e) Position Limits, Reporting Relating to Position Limits and 
Liquidation of Positions and Exercise Limits (CBOE Rules 20.6-20.8) 
    CBOE Rule 20.6 provides that in determining compliance with CBOE 
Rules 4.11, Position Limits, 24.4, Position Limits for Broad-Based 
Index Options, 24.4A, Position Limits for Industry Index Options, and 
24.4B, Position Limits for Options on Micro Narrow-Based Indexes as 
Defined Under Rule 24.2(d), cash-settled Range Options will have 
position limits equal to the position limits for options on the same 
underlying index. In determining compliance with the applicable 
position limits, Range Options must be aggregated with other option 
contracts on the same underlying index, including other classes of 
Range Options overlying the same index.
    CBOE Rule 20.7 provides that Range Options will be subject to the 
same reporting and other requirements triggered for options on the same 
underlying index. In computing reportable Range Options, Range Options 
will be aggregated with other option contracts on the same underlying 
index, including other classes of Range Options overlying the same 
index.
    CBOE Rule 20.8 provides that exercise limits for Range Options will 
be the same as those exercise limits for other options on the same 
underlying index. To illustrate, CBOE Rule 24.4 provides that the 
standard position limit for options on the CBOE Russell 2000 Volatility 
Index (``RVX'') is 50,000 contracts, and the near-term position limit 
is 30,000 contracts. Therefore, the standard position limit for Range 
Options overlying the RVX also will be 50,000 contracts, and the near-
term position limit would be 30,000 contracts. The 30,000 contract 
near-term position limit will also be the applicable exercise limit for 
Range Options on the RVX.\5\
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    \5\See CBOE Rule 24.5, Exercise Limits, which provides, inter 
alia, that in determining compliance with CBOE Rule 4.12, exercise 
limits for index option contracts shall be applicable to the 
position limits prescribed for option contracts with the nearest 
expiration date in CBOE Rules 24.4 or 24.4A.
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    For the purpose of determining compliance with the above limits, 
Range Options on the RVX will be aggregated with all other options on 
the RVX, including all series of Range Options on the RVX. This same 
aggregation will also be utilized to calculate the reporting 
requirements set forth in CBOE Rule 4.13, Reports Related to Position 
Limits.\6\
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    \6\ CBOE Rule 4.13 sets forth the general reporting requirement 
for customer accounts that maintain a position in excess of 200 
contracts (long or short) in any single class of option contracts.
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(f) Determination of Settlement Value of the Underlying Index (CBOE 
Rule 20.9)
    CBOE Rule 20.9 provides that Range Options that are ``in-the-
money,'' or ``out-of-the-money'' will be a function of the settlement 
value of the underlying index and whether at expiration the settlement 
values will fall within or outside of the Range Length.
(g) Premium Bids and Offers; Minimum Increments (CBOE Rule 20.10)
    CBOE Rule 20.10 provides that all bids or offers made for Range 
Option contracts will be deemed to be for one contract unless a 
specific number of option contracts is expressed in the bid or offer. A 
bid or offer for more than one option contract, which is not made all-
or-none, will be deemed to be for that amount or any lesser number of 
option contracts. An all-or-none bid or offer will be deemed to be made 
only for the amount stated. CBOE Rule 20.10 also will provide that all 
bids or offers made for Range Option contracts would be governed by the 
CBOE Rule 24.8, Meaning of Premium Bids and Offers, as that rule 
applies to index options.
(h) Exercise of Range Options (CBOE Rule 20.11)
    CBOE Rule 20.11 provides that Range Options will be exercised at 
expiration if the settlement value of the underlying index falls within 
the Range Length, and that Range Options will be subject to the 
exercise by exception processing procedures set forth in OCC Rules 805 
and 1804. OCC Rules 805 and 1804 contain provisions that, inter alia, 
permit option holders to give instructions to not exercise an option 
contract.
(i) Exchange Authority (CBOE Rule 20.12)
    CBOE Rule 20.12 provides that for purposes of Range Options, 
references in the Exchange's Rules to the appropriate committee shall 
be read to be the Exchange.\7\ The Exchange proposed this provision 
because it may determine to assign the applicable authorities with 
respect to Range Options to committees and/or Exchange staff. This 
provision will provide the Exchange with the flexibility to delegate 
the authorities under the rules with respect to Range Options to an 
appropriate committee or appropriate Exchange staff and will not have 
to make a rule change merely to accommodate the reassignment of such 
authority. For example, the Exchange may determine to delegate the 
authority to determine the applicable opening parameter settings to the 
Office of the Chairman.
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    \7\ Thus, for example, references to determinations regarding 
the applicable opening parameter settings established by the 
``appropriate Procedure Committee'' in CBOE Rule 6.2B, Hybrid 
Opening System (``HOSS''), shall be read to be by the ``Exchange.'' 
See e.g., Securities Exchange Act Release No. 55919 (June 18, 2007), 
72 FR 34495 (June 22, 2007) (rule change providing, inter alia, that 
for purposes of Credit Options, references in the Exchange Rules to 
the appropriate committee shall be read to be the Exchange.).
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    (j) FLEX Trading (CBOE Rule 20.13)
    CBOE Rule 20.13 provides that Range Options will be eligible for 
trading as Flexible Exchange Options, as provided for in Chapter XXIVA 
and XXIVB.\8\ For purposes of CBOE Rules 24A.4 and 24B.4, the parties 
will designate the Range Length, Range Interval and Maximum Exercise 
Value. CBOE Rules 24A.9 and 24B.9, regarding the minimum quote width, 
will not apply to Range Options.
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    \8\ FLexible EXchange[reg] Options (FLEX Options) are customized 
equity or index option contracts that provide investors with the 
ability to customize key contract terms, like exercise prices, 
exercise styles and expiration dates.
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(k) Margin (Amendment to CBOE Rule 12.3)
    The Exchange proposes to amend CBOE Rule 12.3, Margin Requirements, 
to include requirements applicable to Range Options.\9\ Under the 
proposed requirements, for a margin account, no Range Option carried 
for a customer will be considered of any value for purposes of 
computing the margin requirement in the account of such customer and 
each Range Option carried for a customer will be margined separately. 
The initial and maintenance margin required on any Range Option carried 
long in a customer's account will be 100% of the purchase price of such 
Range Option. The initial and maintenance margin required on any Range 
Option carried short in a customer's account will be the Maximum Range 
Exercise Value times the contract multiplier.
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    \9\ The Exchange proposes the addition of new subparagraph (n) 
to CBOE Rule 12.3 for Range Options and proposes to reserve 
subparagraph (m) of this rule. The Exchange will reserve 
subparagraph (m) because it previously proposed to use that 
paragraph to codify margin requirements for a product that is the 
subject of another rule filing. See SR-CBOE-2006-105 (proposal to 
list and trade binary options on broad based indexes).
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    For a cash account, a Range Option carried short in a customer's 
account will be deemed a covered position, and

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eligible for the cash account if either one of the following is held in 
the account at the time the option is written or is received into the 
account promptly thereafter: (i) Cash or cash equivalents equal to 100% 
of the Maximum Range Exercise Value times the contract multiplier; or 
(ii) an escrow agreement. The escrow agreement must certify that the 
bank holds for the account of the customer as security for the 
agreement: (A) Cash, (B) cash equivalents, (C) one or more qualified 
equity securities, or (D) a combination thereof having an aggregate 
market value of not less than 100% of the Maximum Range Exercise Value 
times the contract multiplier and that the bank will promptly pay the 
member organization the cash settlement amount in the event the account 
is assigned an exercise notice.
    The Exchange believes that these proposed levels are appropriate 
because risk exposure will be limited with Range Options and the 
proposed customer initial and maintenance margin will be equal to the 
maximum risk exposure.\10\
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    \10\ In accordance with CBOE Rule 12.10, Margin Required is 
Minimum, the Exchange has the ability to determine at any time to 
impose higher margin requirements than those described above in 
respect of any Range Option position when it deems such higher 
margin requirements are appropriate.
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(l) Options Disclosure Document
    It is expected that OCC will seek a revision to the Options 
Disclosure Document (``ODD'') to incorporate Range Options.
(m) Systems Capacity
    The Exchange represents that it believes the Exchange and the 
Options Price Reporting Authority have the necessary systems capacity 
to handle the additional traffic associated with the listing and 
trading of Range Options.
    The Exchange does not anticipate that there will be any additional 
quote mitigation strategy necessary to accommodate the trading of Range 
Options.
(n) Surveillance Program
    The Exchange represents that it will have in place adequate 
surveillance procedures to monitor trading in Range Options prior to 
listing and trading such options, thereby helping to ensure the 
maintenance of a fair and orderly market for trading in Range Options.

III. Discussion

    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.\11\ Specifically, the Commission finds that the proposal is 
consistent with Section 6(b)(5) of the Act,\12\ 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 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 believes that Range Options would provide 
investors with a potentially useful investment choice. The Commission 
notes that investors now can replicate the features and structure of 
Range Options through the use of currently available options traded on 
the Exchange.\13\
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    \11\ In approving this proposed rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. See 15 U.S.C. 78c(f).
    \12\ 15 U.S.C. 78f(b)(5).
    \13\ The payout structure of a Range Option can be replicated by 
purchasing four calls or puts with varying strike prices. Range 
Options will enable investors to obtain the same payout structure by 
purchasing one option, with the potential of significantly reducing 
investors' transaction costs. Therefore, the Commission is 
designating Range Options as standardized options for purposes of 
the options disclosure framework established under Rule 9b-1 of the 
Act. See Securities Exchange Act Release Nos. 31910 (February 23, 
1993), 58 FR 12056 (March 2, 1993) and 34925 (November 1, 1994), 59 
FR 55720 (November 8, 1994).
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    The Commission notes that it previously approved rules relating to 
the listing and trading of FLEX Options on CBOE, which give investors 
and other market participants the ability to individually tailor, 
within specified limits, certain terms of those options.\14\ The 
current proposal incorporates Range Options that trade as FLEX Options 
into these existing rules and regulatory framework. The Commission 
finds that the Exchange's proposal to allow Range Options to be 
eligible for trading as FLEX Options is consistent with the Act.
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    \14\ See Securities Exchange Act Release No. 31910 (February 23, 
1993), 58 FR 12056 (March 2, 1993).
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    The Commission believes that the proposed position limits and 
margin rules for Range Options are reasonable and consistent with the 
Act. Setting position and exercise limits on Range Options that are 
equal to those limits on options on the same underlying index appears 
to reasonably balance the promotion of a free and open market for these 
securities with minimization of incentives for market manipulation. In 
addition, the proposed margin rules appear reasonably designed to deter 
a member or its customer from assuming an imprudent position in Range 
Options.
    In support of its proposal, CBOE made the following 
representations:
     CBOE has in place an adequate surveillance program to 
monitor trading in Range Options and intends to largely apply its 
existing surveillance program for options to the trading of Range 
Options; and
     CBOE has the necessary systems capacity to support the new 
options series that would result from the introduction of Range 
Options.
    This approval order is based on CBOE's representations.

III. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the Act, 
that the proposed rule change (SR-CBOE-2007-104), as modified by 
Amendment No. 1, is hereby approved.
    It is further ordered, pursuant to Rule 9b-1(a)(4) under the 
Act,\15\ that Range Options are designated as standardized options.
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    \15\ 17 CFR 240.9b-1(a)(4).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\16\
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    \16\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. E8-4104 Filed 3-3-08; 8:45 am]

BILLING CODE 8011-01-P
