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Trading Options over the Counter
Trading options over the counter can be quite profitable. Trading options over the counter also entails risks not seen in standardized options trading. Traders buy options to hedge risk and traders buy and sell options on speculation in search of profits. Both can be reasons for trading options over the counter. Over the counter options are agreements between two trading parties. They are not standardized and there is not secondary market. The contract or strike price is set by the persons involved as are contract expiration dates. The most important and potentially dangerous aspect of trading options over the counter is that there is not a clearing house to provide guarantees of contract performance. This is to say there is significant counterparty risk in over the counter options trading.
Just Like Standardized Trading and Not
Just like trading standardized options, one can buy or sell calls or puts or both when trading options over the counter. Purchasing a call gives the buyer the right to purchase the underlying equity at an agreed upon price. This right persists no matter how high the market price (called the spot price) of the equity may go up. Buying a put gives the buyer the right to sell an underlying equity at an agreed upon price no matter how far the equity it might fall. In no case is the buyer obligated to execute a contract, and he will only do so if it is profitable. On the other hand the sell or a call or put contract is paid for taking a risk. If the price of the equity underlying the options contract performs contrary to expectations the seller can lose significant amounts of money. Here is where the difference between trading options over the counter and trading standardized contracts is important. In standardized options trading there is a secondary market and traders can exit a contract by executing the opposite trade. This is difficult if not impossible in over the counter options trading.
Available Options over the Counter
Because trading options over the counter involved an agreement between two parties, one can trade options on commodities, bonds, stocks, real estate, or various derivatives. Traders agree upon an acceptable expiration date, strike price, and price of the options contract. In addition, settlement terms can be arranged according to the wishes of the two parties and can vary widely.
Inherent Difficulties in Trading Options over the Counter