When the Chicago Board of Trade introduced Treasury options a decade ago, "they bombed," recalls Thomas Coleman, the board's vice president of new product marketing.
But what a difference a decade makes.
A similar product introduced eight months ago has been greeted with an explosion of investor interest.
In contrast to the two-year, five-year and 10-year treasury options that proved to be a dismal fail-me, the board's Flexible Treasury Options have succeeded in stealing thunder from the overthe-counter derivatives market, board officials say.
The reason for the success of the "flex" options is their ability to be molded to fit any risk management situation, said Patrick H. Arbor, the board's chairman.
The board's new series of Treasury products allows the investor to choose contract's strike price, expiration date and offers either American or European exercise style.
Mr. Coleman said the volume of Treasury instruments traded at the board through August 1994 rose 37% over last year. The 10- and five-year instruments were up 57%, he said. And two-year Treasury contracts rose a staggering 101% this year over last.
"The world wants more customization," noted Mr. Coleman.
"The flex options complement standardized options on the CBOT."
Mr. Arbor said the flex options contracts offer investors the best of two worlds - the versatility of the OTC market and the security of an exchange-traded instrument.
When the instruments were introduced, the board targeted them to large, institutional investors, which are the majority of its customers. Flex options initially were traded in 200-contract lots.
But they since have been refined to trade in 100-contract lots, making them cheaper than standard options and available to a wider market.
The instruments are popular with hedge funds and banks, allowing them to profit in highly volatile markets.
Flex options provide a greater degree of precision, board officials said, by enabling the strike prices to be specified in either 1/32 of a point increments for 10year T-note options or in 1/64 of a point increments on two- and five-year T-notes.
Traders of flex options also can select any work day as an expiration date.
The underlying futures contract month is determined by the choice of expiration date, since flex options contract months will be the same as the nearest standard option's expiration month.
But, unlike standard Treasury options traded on the board, flex options expire on the last day of trading.
Since the flex options are traded in the "open outcry" marketplace - where all trades are made verbally and with hand signals some adjustments in trading had to be made.
The minimum trading size for flex options is 100 contracts or $10 million.
Once a "request for quote" is submitted, a 10-minute interval elapses in which no trading takes place.
This alerts floor traders to a new request for quote, gives them time to price the options and allows off-exchange traders time to convey this information to their clients and get in on a trade.
According to Jim Chrystal, senior marketing manager for flex options, the board just took an existing idea and made it better.
"We took a standardized option and decided to let traders customize their own product."
Mr. Chrystal admitted that while the board is trying to compete head-to-head with the overthe-counter markets, it may never be able to compete on every product. Each market offers investors specific advantages that the other cannot duplicate, he said.
"[Flex contracts are] still an option on a futures contract," he explained. "This is not an exchange-traded OTC product. It is a customized exchange product."
He also explained that even though flex options have been available at the board for the past eight months, the board is still making modifications on the instruments.
"We've been learning on the go," said Mr. Chrystal.
"A lot of guys making markets in these things are not on the floor. We started out with a 15-minute response time. Then we found out you only need 10 minutes to get a two-sided market."
He also said the minimum contract size was lowered from its initial 200 lots to 100 lots.
Mr. Chrystal said the board averages 1,500 flex options trades a week.
The single largest trade to date was a block of 7,000 bought by a hedge fund manager.
"Flex is supposed to give our traders and customers the ability to trade options they don't usually have access to," he said.
