The opportunity to design and tweak an option to gain more financial benefit has been made possible through FLEX options. This investment vehicle was created in 1993 by the Chicago Board Options Exchange. FLEX options, also known as Flexible Exchange, have provided a unique alternative to over-the-counter options.
What They Are
FLEX Options were designed to track the value of a stock. They allow the buyer and seller to customize their options by further discussing the terms on the deals. Market participants, such as pension funds, money managers and insurance companies, can customize according to size, expiration date (which has ranged between one and five years), exercise style (American or European) and certain exercise prices. (For a background on this topic, see our Options Basics Tutorial.)
The first types of FLEX options were contracts on stock market indices. Initially, they were available on the S&P 100 and the S&P 500 indices. Now, they are accessible on the Dow Jones Industrial Average and Nasdaq 100.
Equity Flex options or E-FLEX debuted in 1996 on the Chicago Board Options Exchange, American Stock Exchange and the Pacific Stock Exchange. A minimum of 250 contracts had to be traded in order to open a new E-FLEX series. A minimum of 100 contracts were required to trade an existing E-FLEX series. The options were targeted to large institutional investors because the options have had a minimum face value of $10 million.
The Securities Exchange Commission eliminated position and exercise limits a year later. These limitations created a ceiling on the total number of options contracts on the same side of the market that an investor or group of investors acting together may hold or write, according to the American Stock Exchange. In most cases, the E-FLEX positions couldn't go beyond "75,000 contracts, representing only 7.5 million shares of underlying stock." Removing these limits allowed major institutions to use options on a greater level.
FLEX options transactions use to be paper intensive. According to the study, "Reducing the Market Impact of Large Stock Trades" in the Journal of Portfolio Management, the investor began the process by going to a broker or dealer. The broker contacted the floor of the exchange, such as AMEX. The broker also completed a request for quote form. This form described the terms of the contracts for the bids and or offers that are solicited. Next, the form went to the specialist responsible for options. This specialist fixed a request response time that occurred within a couple of minutes to twenty minutes for responding quotes. The trade was assigned an alphanumeric number. The proposed trade was put on the Options Price Reporting Authority tape. Off-floor dealers and customers bid or sent offers to their brokers to contact specialist. Once that time ended, the best bid and offer were sent out on the Options Price Reporting Authority. (For more, check out Electronic Trading: The Role Of A Specialist.)
The demand for options started to dwindle so the process became automated in 2007 with CFlex, an online platform. The virtual environment cut costs and reduced the time for orders and request for quotes.
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The Pros and Cons
Brokers frustrated with the manual process were relieved when the trading of FLEX options became fully automated. It made trading more secure in a real-time environment. These options also have the benefit of the efficiency of auction market price discovery. They offer liquidity, allowing investors to get out early rather than buy a way out.
Transparency is created because the credit risk is reduced as opposed to the over-the-counter-market of options. The OTC market relied on the credit-worthiness of the firm selling the option. However, customized options are issued and guaranteed by the Options Clearing Corporation. The OCC has an AAA rating from Standard & Poor's Corporation. (To learn more, see A Brief History Of Credit Rating Agencies.)
Some brokers and dealers are calling for fairer and more consistent prices in order for the pricing to become more competitive. They also are looking into reducing the response time in a move to prevent too much information about the trade from getting disseminated.
The Bottom Line
FLEX options have undergone several changes since its creation in the early 1990s. They may be similar in structure to over the counter options but among their differences is the elasticity offered. The perks of this investment product include the issuance and guarantee of the Options Clearing Corporation which has a high credit rating and helps to ensure the checks and balances of credit worthiness. One of its disadvantages is the length of the response time which allows private information to seep out. Flex options are likely to undergo even more changes as more efforts are made to broaden their access. (To learn more, read The Basics Of Buying Options.)