What is an OTC option. Over-the-counter (finance)

OTC Options

The various puts and calls for given security will be shown for different expiration what is an OTC option, going out as far as a couple of years in the case of LEAPs.

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These types of options are listed on an exchange and trade through a clearinghouse. Don't panic—it sounds more advanced than it is.

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Without going into the technical details, what it effectively means is that the performance of your option is guaranteed by the exchange itself. Each participant is charged a fee to help cover potential default, with the odds considered remote. The option you bought had to be sold by someone, perhaps a conservative investor who was selling covered calls as part of a buy-write transaction.

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They have to deliver the stock. What if they died?

Section 5. The details specified for the broker, including the brokerage rule linked to the broker, is defaulted. However, you can change some details, like whether brokerage should be booked in advance or in arrears or whether it should be waived altogether. You will be allowed to enter details of a broker only if brokerage was allowed for the product to which the contract is associated. Payable Currency and Brokerage Currency If the brokerage payable currency is the same as the brokerage paid currency, then the same amounts brokerage paid and brokerage payable are displayed against the currencies.

Went bankrupt? Thus, there is virtually no counterparty risk.

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How Over-the-Counter Options Differ from Regular Stock Options In essence, over-the-counter options are private party contracts written to the specifications of each side of the deal.

There are no disclosure requirements and you are limited only in your imagination as to what the terms of the options are.

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In an extreme example, you could structure an over-the-counter option with another party that required that person to deliver a set number of troy ounces of pure karat gold based upon the number of whales spotted off the coast of Japan over the next 36 months.

While that might be a very stupid transaction, you get the idea that you can write essentially any terms for these options.

  • The minimum transaction amount is EUR 40,
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  • An over the counter OTC derivative is a financial contract that does not trade on an asset exchange, and which can be tailored to each party's needs.
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  • OTC options are exotic options that trade in the over-the-counter market rather than on a formal exchange like exchange traded option contracts.

The appeal of over-the-counter options is that you can transact in private and negotiate the terms. Counterparty Risk in Over-the-Counter Options A major concern with over-the-counter options is that they lack the protection of an exchange or clearinghouse.

OTC Options

You are effectively relying on the promise of the counterparty to live up to their end of the deal. Using the over-the-counter options is especially dangerous when used to hedge your exposure to some risky asset or security.

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That is why the world financial institutions panicked when Lehman Brothers failed in —as a huge investment bank, they were party to countless over-the-counter options that would have entered a black hole of the bankruptcy court. It only takes a few over-the-counter derivative transactions before it becomes virtually impossible to determine the total exposure an institution would have to a given event or asset. The problem becomes even more complex when you realize that you may be in a position where your firm could be wiped out because one of your counterparties had their counterparty default on them, making them insolvent.

It is why famed investor Warren Buffett had referred to unchecked derivatives as financial weapons of mass destruction.

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