As the contest on the floor continued, the rise of index options remade the market. In 1982 the Chicago Mercantile Exchange introduced futures based on the Standard & Poor's 500. In March 1983 the CBOE followed suit with options trading on the S&P 100 index. These index options were popular, as they allowed traders to speculate or hedge on the movement of the entire market.
Within a year, S&P 100 index options accounted for about 42 percent of the CBOE's daily volume. By the end of the decade they were the most actively traded options in the United States. Index options on the S&P 500, introduced a few months later, had a slower start but eventually proved similarly successful.85
Index options were not an unqualified blessing. During the 1980s, professionals increasingly turned to program trading, employing computers to bet on the spreads between index options, index futures, and their underlying stocks. The result was an unprecedented level of volatility across all of the markets. On October 19, 1987, the Dow Jones Industrial Average plunged by more than 22 percent. Market makers were hard hit as the index options swung wildly. Program trading based on derivatives was widely considered the main cause of the break. For the CBOE, a few traumatic days were succeeded by months of discouragement as options fell out of favor and the market lost more than half its volume.86
CBOE leadership seized this opportunity to make overdue reforms. The CBOE converted market makers to a "designated primary market maker" arrangement, which was—despite its name—a traditional specialist system, and implemented measures that made the exchange more hospitable to institutional business. It was this institutional volume that helped the CBOE return to former trading levels in 1994.87
(85.) Wall Street Journal, April 3, 1984; Wall Street Journal, December 14, 1987, and January 8, 1988; CBOE Annual Reports, 1991 and 1993; New York Times, April 24, 1988.
(87.) CBOE Annual Reports, 1975, 1989, 1990, and 1994.
(Courtesy of Alton Harvey)
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