
[Federal Register Volume 77, Number 110 (Thursday, June 7, 2012)]
[Notices]
[Pages 33802-33805]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-13763]



[[Page 33802]]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-67086; File No. SR-CBOE-2012-043]


Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Notice of Filing of a Proposed Rule Change Relating to 
Spread Margin Rules

May 31, 2012.
    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 May 29, 2012, the Chicago Board Options Exchange, Incorporated 
(``Exchange'' or ``CBOE'') filed with the Securities and Exchange 
Commission (``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.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    This filing proposes universal spread margin rules. The text of the 
proposed rule change is available on the Exchange's Web site (http://www.cboe.com/AboutCBOE/CBOELegalRegulatoryHome.aspx), at the Exchange's 
Office of the Secretary, 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 the 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    An option spread is typically characterized by the simultaneous 
holding of a long and short option of the same type (put or call) where 
both options overly the same security or instrument, but have different 
exercise prices and/or expirations. To be eligible for spread margin 
treatment, the long option may not expire before the short option. 
These long put/short put or long call/short call spreads are known as 
two-legged spreads.
    Since the inception of the Exchange, the margin requirements for 
two-legged spreads have been specified in CBOE margin rules.\3\ The 
margin requirement for a two-legged spread that is eligible for spread 
margin treatment is its maximum risk based on the intrinsic values of 
the options, exclusive of any net option premiums paid or received when 
the positions were established.\4\ For example, consider the following 
equity option spread:
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    \3\ Chapter 12. Rule 12.3(c)(5)(C)(4).
    \4\ Any net credit received for establishing a spread may be 
applied to the margin requirement, if any. In the case of a spread 
that is established for a net debit, the net debit must be paid for 
in full.

Long 1 XYZ May2011 60 call
Short 1 XYZ May2011 50 call

    The maximum potential loss (i.e., risk) for this particular spread 
would be a scenario where the price of the underlying stock (XYZ) is 
$60 or higher. If the market price of XYZ is $60, the May2011 60 call 
would have an intrinsic value of zero, because the right to buy at $60 
when XYZ can be purchased in the market for $60 has no intrinsic value. 
The May2011 50 call would have an intrinsic value of $10 because of the 
$10 advantage gained by being able to buy at $50 when it costs $60 to 
purchase XYZ in the market. Because each option contract controls 100 
shares of the underlying stock, the intrinsic value, which was 
calculated on a per share basis, is multiplied by 100, resulting in an 
aggregate intrinsic value of $1,000 for the May2011 50 call.\5\ 
However, because the May2011 50 call is short, the $1,000 intrinsic 
value is a loss, because it represents the cost to close (i.e., buy-
back) the short option. At an assumed XYZ market price of $60, netting 
the intrinsic values of the options results in a loss of $1,000 (-
$1,000 + 0).\6\ Therefore, the maximum risk of, and margin requirement 
for, this spread is $1,000. If there is no maximum risk (i.e., there is 
no loss calculated at any of the exercise prices found in the spread), 
no margin is required, but under Exchange margin rules any net debit 
incurred to establish the spread would be required to be paid for in 
full. Current CBOE Rule 12.3(c)(5)(C)(4) provides that, when the 
exercise price of the long call (or short put) is less than or equal to 
the exercise price of the offsetting short call (or long put), no 
margin is required; and that when the exercise price of the long call 
(or short put) is greater than the exercise price of the offsetting 
short call (or long put) the amount of margin required is the lesser of 
the margin requirement on the short option, if treated as uncovered, or 
the difference in the aggregate exercise prices. The intrinsic value 
calculation described above is essentially expressed, in different 
words, in the current rule language.
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    \5\ The result would be multiplied by the number of contracts 
when more than a one-by-one contract spread is involved.
    \6\ At an assumed market price of $50, both the May2011 50 call 
and May2011 60 call would have no intrinsic value. Thus, there is no 
risk (provided any net debit is paid for in full) at an assumed 
market price of $50.
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    The maximum risk remains constant at $1,000 for XYZ market prices 
higher than $60 because for each incremental increase in the assumed 
market price of XYZ above $60, the loss on the short option is equally 
offset by a gain on the long option in terms of their intrinsic values. 
By calculating the net intrinsic value of the options at each exercise 
price found in the spread, as in the computation exemplified above, the 
maximum risk of, and margin requirement for, any two-legged spread can 
be determined.
    On August 23, 1999, the Exchange implemented specific definitions 
and margin requirements for butterfly spreads and box spreads.\7\ In a 
butterfly spread, a two-legged spread is combined with a second two-
legged spread (same type--put or call--and same underlying security) as 
in the following example:
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    \7\ The butterfly and box spread margin rules, and various other 
CBOE margin rule changes, were approved by the Securities and 
Exchange Commission on July 27, 1999. See Securities Exchange Act 
Release No. 41658 (July 27, 1999), 64 FR 42736 (SR-CBOE-97-67).

Long 1 XYZ May2011 50 call
Short 1 XYZ May2011 60 call

Long 1 XYZ May2011 70 call
Short 1 XYZ May2011 60 call

    Note that a short XYZ May2011 60 call option is common to both two-
legged spreads. Therefore, by adding the May2011 60 call options 
together, the two spreads can be combined to form a butterfly spread as 
follows:

Long 1 XYZ May2011 50 call
Short 2 XYZ May2011 60 calls
Long 1 XYZ May2010 70 call \8\
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    \8\ This configuration represents a long butterfly spread. The 
opposite (i.e., short 1 XYZ May2011 50 call, long 2 XYZ May2011 60 
calls and short 1 XYZ May2011 70 call) would be a short butterfly 
spread.

    The margin requirement for a butterfly spread is its maximum risk. 
The maximum risk can be determined

[[Page 33803]]

in the same manner as demonstrated above for two-legged spreads. In 
this example, the net intrinsic values would be calculated at assumed 
prices for the underlying of $50, $60 and $70, which are the exercise 
prices found in the butterfly spread. The greatest loss, if any, from 
among the net intrinsic values is the margin requirement. For this 
particular butterfly spread, there is no loss in terms of net intrinsic 
values at any of the assumed underlying prices ($50, $60 or $70). 
Therefore, there is no margin requirement. However, the net debit 
incurred to establish this butterfly spread must be paid for in full.
    In a box spread, a two-legged call spread is combined with a two-
legged put spread. The exercise prices of the long and short put 
options are the reverse of the call spread. All options have the same 
underlying security and expiration date. An example is as follows:

Long 1 XYZ May2011 50 call
Short 1 XYZ May2011 60 call

Long 1 XYZ May2011 60 put
Short 1 XYZ May2011 50 put \9\
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    \9\ This configuration represents a long box spread. The 
opposite (i.e., short 1 XYZ May2011 50 call, long 1 XYZ May2011 60 
call, short 1 May2011 60 put and long 1 XYZ May2011 50 put) would be 
a short box spread.

    The margin requirement for a box spread, unless all options are 
European style, is its maximum risk. The maximum risk of a box spread 
can be determined in the same manner as demonstrated above for two-
legged spreads and butterfly spreads. In this example, the net 
intrinsic values would be calculated at assumed prices for the 
underlying of $50 and $60, which are the exercise prices found in the 
box spread. The greatest loss, if any, from among the net intrinsic 
values is the margin requirement. For this particular box spread (long 
box spread), there is no loss in terms of net intrinsic values at 
either of the assumed underlying prices ($50 or $60). Therefore, there 
is no margin requirement. However, the net debit incurred to establish 
this box spread must be paid for in full. In the case of a long box 
spread where all options are European style, the margin requirement is 
50% of the difference in the exercise prices (in aggregate).\10\
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    \10\ A 50% margin requirement is allowed because a long box 
spread has an intrinsic value at expiration equal to the difference 
in the exercise prices (in aggregate), which will more than cover 
the net debit incurred to establish the spread. A long box spread 
is, essentially, a riskless position. The difference between the 
value of the long box spread realizable at expiration and the lower 
cost to establish the spread represents a risk-free rate of return.
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    On August 13, 2003, the Exchange issued a Regulatory Circular 
(RG03-066) to define additional types of multi-leg option spreads, and 
to set margin requirements for these spreads through interpretation of 
Exchange margin rules. The Regulatory Circular had been filed with the 
Commission and was approved on August 8, 2003, on a one-year pilot 
basis.\11\ The Regulatory Circular was reissued as RG04-90 (dated 
August 16, 2004) and RG05-37 (dated April 6, 2005) pursuant to one-year 
extensions of the pilot granted by the Commission on August 6, 2004, 
and March 22, 2005, respectively.\12\
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    \11\ See Securities Exchange Act Release No. 48306 (Aug. 8, 
2003), 68 FR 48974 (Aug. 15, 2003) (SR-CBOE-2003-24).
    \12\ See Securities Exchange Act Release No. 50164 (Aug. 6, 
2004), 69 FR 50405 (Aug. 16, 2004) and Securities Exchange Act 
Release No. 51407 (Mar. 22, 2005), 70 FR 15669 (Mar. 28, 2005).
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    The Regulatory Circular identified seven spread strategies by 
presenting an example of each spread's configuration, and numbering 
each configuration, rather than designating the configurations by names 
commonly used in the industry. The seven configurations would be 
referred to in the industry as:

Long Condor Spread,
Short Iron Butterfly Spread,
Short Iron Condor Spread,
Long Calendar Butterfly Spread,
Long Calendar Condor Spread,
Short Calendar Iron Butterfly Spread and
Short Calendar Iron Condor Spread.

    On July 30, 2004, the Exchange filed proposed rule amendments with 
the Commission to codify the provisions of the Regulatory Circular in 
Exchange margin rules. Included in the proposal were definitions of 
Long Condor Spread (which includes a Long Calendar Condor Spread), 
Short Iron Butterfly Spread (which includes a Short Calendar Iron 
Butterfly Spread), and Short Iron Condor Spread (which includes a Short 
Calendar Iron Condor Spread). In addition, it was proposed that the 
existing definition of Long Butterfly Spread be amended to include a 
Long Calendar Butterfly Spread. The margin requirements, specific to 
each type of spread, as had been set-forth in the Regulatory Circulars, 
were also proposed for inclusion in Exchange margin rules.\13\ 
Contemporaneously, the New York Stock Exchange filed similar margin 
rule proposals with Commission.\14\ CBOE's proposed rule amendment was 
approved by the Commission on December 14, 2005.\15\
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    \13\ See Securities Exchange Act Release No. 52739 (Nov. 4, 
2005), 70 FR 69173 (Nov. 14, 2005) (SR-CBOE-2004-53). This release 
also noticed a partial amendment (Amendment No. 1) that was filed on 
August 23, 2005 (in coordination with the New York Stock Exchange).
    \14\ See Securities Exchange Act Release No. 52738 (Nov. 4, 
2005), 70 FR 68501 (Nov. 10, 2005) (SR-NYSE-2004-39). For approval 
order, see Securities Exchange Act Release No. 52951 (Dec. 14, 
2005), 70 FR 75523 (Dec. 20, 2005).
    \15\ See Securities Exchange Act Release 52950 (Dec. 14, 2005), 
70 FR 75512 (Dec. 20, 2005).
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    Because a number of variations are possible for each basic type of 
multi-leg option spread strategy, it is problematic to maintain margin 
rules specific to each.\16\ It becomes difficult to continually 
designate each variation by name, and define and specify a margin 
requirement for it in the rules. For example, consider the following 
spreads:
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    \16\ A long calendar butterfly spread is an example of a 
variation. The basic type would be butterfly spread. In a long 
calendar butterfly spread, one of the long options expires after the 
other two options expire concurrently, whereas in the basic 
butterfly spread, all options expire concurrently. Another example 
of a variation of a butterfly spread would be a configuration where 
the intervals between the exercise prices involved are not equal. In 
a basic butterfly spread, the intervals are equal (i.e., symmetric).

Long 10 XYZ May2011 50 call
Short 10 XYZ May2011 55 call

Long 5 XYZ May2010 70 call
Short 5 XYZ May2011 60 call

    These two spreads combined are a variation of a condor spread. In a 
basic condor spread, the number of option contracts would be equal 
across all option series and the interval between the exercise prices 
of each spread would be equal. In the above variation, there is a 10-
by-10 contract spread vs. a 5-by-5 contract spread, and a spread with a 
5 point interval between exercise prices vs. a spread with a 10 point 
interval between exercise prices. The two spreads in the above example 
offset each other in terms of risk, and no margin requirement is 
necessary. However, margin of $5,000 is required under the Exchange's 
current margin rules, because this variation of the condor spread is 
not specified in the rules. Because it is not recognized in Exchange 
margin rules, the two spreads must be treated as separate, unrelated 
spread strategies for margin purposes. As a result, spread margin of 
$5,000 is required (on the May2011 70/May2010 60 call spread) versus no 
requirement (other than pay for the net debit in full), if the two 
spreads could be recognized as one strategy.
    This rule filing proposes a single, universal definition of a 
spread and one spread margin requirement that consists of a universal 
margin requirement computation methodology. In this manner, the margin 
requirement for all types of option spreads would be covered by a 
single rule, without regard to the number of option series involved or 
the term commonly used in the

[[Page 33804]]

industry to refer to the spread. This would eliminate the need to 
define, and refer to, particular spreads by monikers commonly used in 
the industry. Therefore, this rule filing proposes to eliminate 
definitions of each particular spread strategy (e.g., butterfly, 
condor, iron butterfly, iron condor, etc.), with one exception.
    The one exception would be ``Box Spreads.'' A definition for ``Box 
Spread'' would be retained because loan value is permitted under 
Exchange margin rules for box spreads. Box spreads are the only type of 
spread that is eligible for loan value. They, therefore, need to be 
specially identified in the rules.
    Additionally, the proposed rule changes would automatically enable 
variations not currently recognized in Exchange margin rules (because 
only a limited number of specific spread strategies are defined) to 
receive spread margin treatment.
    A new definition of a spread is proposed as Rule 12.3(a)(5). The 
key to the definition is that it designates a spread as being an 
equivalent long and short position in different call option series and/
or equivalent long and short positions in different put option series, 
or a combination thereof.\17\ With respect to equivalency of long and 
short positions, the definition further requires that the long and 
short positions be equal in terms of the aggregate value of the 
underlying security or instrument covered by each leg. The aggregate 
value equivalency is included so that it is clear that a spread 
composed of one standard option contract and one reduced value option 
contract covering the same underlying security or instrument would be 
permissible. For example, if reduced value options, equal to 1/10th the 
value of a standard option contract are trading, a spread consisting of 
10 reduced value contracts vs. one standard contract would be 
permissible.\18\ As with spreads under the current rule, the proposed 
rule further requires that the short option(s) expire after, or at the 
same time as, the long option(s). Additionally, under the proposed rule 
definition, all options in a spread must have the same exercise style 
(American or European) and either be composed of all listed options or 
all over-the-counter (OTC) options. Spreads that do not conform to the 
definition would be ineligible for spread margin treatment.
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    \17\ An option series means particular exercise price and 
expiration date with respect to a put or call option.
    \18\ Currently, spreads consisting of standard contracts and 
reduced value contracts are permitted by the rules, although the 
current rule does not go into detail to require equivalent aggregate 
underlying value between the long and short legs.
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    Amendments to CBOE Rule 12.3(c)(5)(C)(4) are proposed to implement 
language specifying how a margin requirement is to be computed for any 
spread that meets the definition, and limit eligibility for spread 
margin treatment to spreads that meet the definition. The computational 
method would require that the intrinsic value of each option series 
contained in a spread be calculated for assumed prices of the 
underlying security or instrument. The exercise prices of the option 
series contained in the spread would be required to be used as the 
assumed prices of the underlying security or instrument. For each 
assumed price of the underlying, the intrinsic values would be netted. 
The greatest loss from among the netted intrinsic values would be the 
spread margin requirement. As an example, consider the following 
spread:

Long 1 XYZ May2011 50 put
Short 1 XYZ May2011 60 put
Short 1 XYZ May2011 65 call
Long 1 XYZ May2011 70 call

    This spread is a variation of an iron condor spread. It consists of 
a put spread and a call spread, with all options covering the same 
underlying security or instrument. There are an equal number of 
contracts long and short in both the put spread and call spread. The 
short options expire with or after the long options (with, in this 
case). It is assumed that all options are of the same exercise style 
(American or European). This spread would, therefore, be eligible for 
the spread margin requirement computation in this proposed rule 
amendment.
    Note that in this example, the interval between the exercise prices 
in the put spread is greater than the interval in the call spread. In a 
basic iron condor spread, these intervals are equal. This particular 
configuration is not recognized under current Exchange margin rules. 
Therefore the component put spread and call spread must be viewed as 
separate, unrelated strategies for margin purposes. Under current 
Exchange margin rules, there is a $1,000 margin requirement on the put 
spread and $500 margin requirement on the call spread. However, there 
are offsetting properties between the two spreads, and, if viewed 
collectively, a total margin requirement of $1,500 is not necessary. 
Using the proposed computational methodology, a margin requirement 
would be calculated as follows:

          Intrinsic Values for Assumed Prices of the Underlying
------------------------------------------------------------------------
           Spread                  $50        $60      $65        $70
------------------------------------------------------------------------
Long 1 XYZ May2011 50 put...            0         0        0          0
Short 1 XYZ May2011 60 put..      $(1,000)        0        0          0
Short 1 XYZ May2011 65 call.            0         0        0      $(500)
Long 1 XYZ May2011 70 call..            0         0        0          0
                             -------------------------------------------
    Net intrinsic values....      $(1,000)        0        0      $(500)
------------------------------------------------------------------------

    The greatest loss from among the netted intrinsic values is 
$1,000.\19\ Under the proposed rule amendments, this would be the 
margin requirement. This spread margin requirement is $500 less than 
that required under current Exchange margin rules. Note that under both 
the current and proposed rules, any net debit incurred when 
establishing the spread is required to be paid for in full.
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    \19\ Again, depending on the type of spread strategy, there may 
be no loss among the netted intrinsic values, in which case there 
would be no margin requirement.
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    It can be intuitively shown that the put spread and call spread in 
the example do not have $1,500 of risk when viewed collectively. If the 
price of the underlying is at or above $60, the put spread would have 
no intrinsic value. At or below $65, the call spread would have no 
intrinsic value. Thus, both spreads would never be at risk at any given 
price of the underlying. Therefore, margin need be required on only one 
of the spreads--the one with the highest risk. In this example, the put 
spread has the highest risk ($1,000), and that is the risk (and margin 
requirement)

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that would be rendered by the proposed computational methodology.
    In summary, the proposed rule amendments would enable the Exchange, 
for margin purposes, to accommodate the many types of spread strategies 
utilized in the industry today in a fair and efficient manner.
2. Statutory Basis
    The Exchange believes that the proposed rule change is consistent 
with Section 6(b) \20\ of the Act and the rules and regulations under 
the Act, in general, and furthers the objectives of Section 
6(b)(5).\21\ Because this rule filing proposes a single, universal 
definition of a spread and one spread margin requirement that consists 
of a universal margin requirement computation methodology, it promotes 
just and equitable principles of trade and fosters cooperation and 
coordination with persons engaged in facilitating transactions in 
securities. By adding clarity and consistency to margin requirements, 
it also removes impediments to and perfects the mechanisms 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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    \20\ 15 U.S.C. 78f(b).
    \21\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    CBOE 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 
proposed rule change.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 45 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    (A) By order approve or disapprove such proposed rule change, or
    (B) Institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. 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 email to rule-comments@sec.gov. Please include 
File Number SR-CBOE-2012-043 on the subject line.

Paper Comments

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

All submissions should refer to File Number SR-CBOE-2012-043. This file 
number should be included on the subject line if email is used. To help 
the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's Internet 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 Web site viewing and 
printing in the Commission's Public Reference Room, 100 F Street NE., 
Washington, DC 20549 on official business days between the hours of 
10:00 a.m. and 3:00 p.m. Copies of such filing also will be available 
for inspection and copying at the principal office 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-2012-043 and should be 
submitted on or before June 28, 2012.
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    \22\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\22\
Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2012-13763 Filed 6-6-12; 8:45 am]
BILLING CODE 8011-01-P


