Over the Counter Options
Traders looking to buy options to hedge risk or simply speculate in the options market may consider over the counter options. Over the counter options are not traded on an options exchange and are essentially contracts between two parties. There is no secondary market for such vehicles. Strike prices are not standardized nor are expiration dates. Traders may find great opportunities in over the counter options but will need to be aware of the counter party risk involved. In other words, in over the counter options trading there is no clearing house to guarantee that both parties will abide by the terms of the options contract.
Over the counter trading works much like standardized options trading in that traders buy or sell puts and calls on an underlying equity. Buying a call gives the trader the right to purchase the equity in question at a set price on or before the expiration date of the options contract. Buying a put gives the trader the right to sell the equity in question at a set price on or before the expiration of the options contract. Sellers seek to profit from selling calls and puts but assume the risk of loss in the agreement in return for a payment by the buyer.
What Can I Trade in Over the Counter Options?
One can trade stocks, bonds, commodities or derivatives over the counter. Trading over the counter does not in any way limit the range of options trading. Any options agreement between two parties is possible. Options over the counter use calls and puts just like standardized options trading. However, expiration dates can be whenever the two parties wish them to be. The strike price of a non-standard option can also be subject to negotiation. Likewise the terms of settlement may vary by contract.
What Are the Risks of Over the Counter Options Trading?
The major risk of over the counter options trading is counterparty risk. Those wishing to trade non-standard options may wish to look closely at the exact wording of the options contract and consider a third party insurer to guarantee again the other party not fulfilling their contract obligations. Traders may choose to go over the counter in order to trade options on an equity when the same opportunity does not exist in standardized options trading. A risk inherent in trading over the counter options is that there is not a large market which, by its nature, tends to result in fair and liquid pricing. Traders may pick up great deals in the over the counter options market and they can get badly stung. Some of the more profitable options strategies using technical trading techniques will not be available in a non-liquid market.
Why Engage in Over the Counter Options Trading?
By going over the counter two interested parties can trade options on virtually any equity that they wish. These can include penny stocks, for example.