Chicago may be known as the Second City, but when it comes to derivatives, it's second to none.
There's the so-called "Chicago School" of economic theory, led by economists from the University of Chicago; the Chicago Mercantile Exchange, where financial and agricultural futures are traded; and the Chicago Board of Trade, which was founded in 1848 by grain merchants and expanded in the 1970s to include trading of financial futures and options.
Then there is the Chicago Board Options Exchange, or CBOE, which opened in a CBOT smoking lounge in 1973. There, some CBOT grain traders, ex-stockbrokers and a few put and call brokers from New York launched the world's first listed options marketplace. By the end of 1973, about 1.1 million options contracts had traded — all on the CBOE. Last year, more than 780 million contracts changed hands in the United States alone.
Gary Lahey, an early CBOE options trader who went on to become vice chairman in the mid-1980s and continues to trade options today, said the success of the CBOE did nothing less than create the environment that has led to many financial innovations that are now used by institutional investors around the world.
"Institutions understand how to use options, and they use an awful lot of products with embedded options in them," Mr. Lahey said. "I think that stems from the success of the CBOE."
He said the success of the CBOE led financial analysts to think of other ways to use the risk management characteristics of options to develop new products in their never-ending effort to improve return.
"Options are the single-most useful investment tool there is," he said. "You can replicate any other (investment) tool with them in ways that other financial products cannot. Clearly the growth of derivatives — both listed and unlisted — is in large part due to the success of options."
It wasn't always that way.