Otc options trading

By: Tech2 Date: 14.07.2017

The various puts and calls for a given security will be shown for different expiration dates, going out as far as a couple of years in the case of LEAPs. These types of options are listed on an exchange and trade through a clearinghouse.

Don't panic - it sounds advanced but it's not. Without going into the technical details, what it effectively means is that the performance of your option is guaranteed by the exchange itself.

OTC Options

Each participant is charged a fee to help cover potential default, with the odds considered remote. For sake of clarity in the following example, I'll keep the original prices shown at the time I originally published this article in June, 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.

They have to deliver the stock. What if they died? Thus, there is virtually no counterparty risk. For the well-heeled investor, this presents no problem because he or she can work with an investment bank through their wealth manager to structure custom over-the-counter options tailored to their exact needs. In essence, these are private party contracts written to the specifications of each side of the deal.

O-T-C OPTIONS TRADING SET FOR ALL EXCHANGES - ysygohajavin.web.fc2.com

There are no disclosure requirements and you are limited only in your imagination as to what the terms of the over-the-counter options are. In an extreme example, you and I could structure an over-the-counter option that required me to deliver a set number of Troy ounces of pure 24 karat gold based upon the number of whales spotted off the coast of Japan over the next 36 months.

Coal - Futures, Options and OTC Clearing - CME Group

The appeal of over-the-counter options is that you can transact in private and negotiate terms. The problem with over-the-counter options is that they lack the protection of an exchange or clearinghouse.

You are effectively relying on the promise of the counterparty to live up to their end of the deal. This is especially dangerous if you were using the over-the-counter options to hedge your exposure to some risky asset or security.

That is why the world financial institutions panicked when Lehman Brothers failed — as a huge investment bank, they were party to countless over-the-counter options that would have entered a black hole of 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.

This is why famed investor Warren Buffett had referred to unchecked derivatives as financial weapons of mass destruction. Search the site GO.

otc options trading

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