There's a problem with ESXi and USB devices which I don't think has been fixed yet. You should be able to get around it by using a generic SCSI device.
Yes, your right I think its a USB DVD Drive.... Even though its an internal drive that is already built in that comes with the server. There are NO other SCSI devices that it can find as it shows that option as Unavailable. Also delete and tried adding the CD/DVD again and I guess I got around this the first time by selecting connecting a Client CD/DVD vs. a Host DVD ... but this time when just adding a Host CD/DVD its not showing anything for this drop down. So yes, hitting a bug probably or driver issue with update 2 is this version I'm running with the x3650 servers. I can create an ISO out of it and do what I need that way, but this is sort of a bummer for now so hopefully this will be resolved in Update 3.
Thanks