ETD and OTC options are derivative products where a contract is in place so that the holder of the option has the ability to exchange it for a specified underlying instrument, at a specified price, before or at a specified time. The difference between ETD and OTC options relates less to the nature of that contract.
The abbreviation ETD stands for Exchange Traded Derivatives. An ETD option also sometimes referred to as a ‘listed option’ is one traded on a regulated exchange where the terms of the option contract are standardized by the exchange. The regulated exchanges include for example, the CBOE (Chicago Board Options Exchange) and London Metals Exchange (LME). The terms set by these exchanges might dictate if the option can be expired prior to expiry date or only at expiry date? What are known as ‘American Options’ allow the holder to exercise and convert to the underlying on or before expiration date whereas ‘European Options’ can only be exercised on expiration date.
As well as the ETD option itself being traded on a regulated exchange the underlying instrument must also be listed on a regulated exchange. All of this regulation provides the benefit of ETD options being guaranteed against default through a clearinghouse.
Over the counter options, OTC options, or as they are sometimes called, ‘exotic’ options, are a more bespoke product. The over the counter-reference correctly intimates that the nature of the transaction is one between two parties. Traders looking for particular terms might not be able to use ETD options to achieve their aim. For example, an investor might be looking to hold an option with a specific strike price or expiry date, one not provided in ETD form. Being able to define your own terms can have its advantages but typically this is accompanied by extra costs and is reflected in the buyer of the option paying a higher premium (price) to hold the option. Another potential downside is that the option writer (not the clearinghouse) is obliged to meet the terms of any exercised options. Credit risk plays a factor and is the reason that OTC options tend to be traded between institutions and banks.
Question
Justin Freeman
Link to comment
Share on other sites
2 answers to this question
Recommended Posts
Join the conversation
You can post now and register later. To reply to this question, sign in or create a new account.