OTC options are custom-made financial contracts between two parties. Unlike stock market options that are traded on an exchange (like NSE or BSE), OTC options are private deals, usually done between big companies, banks, or financial firms.
Think of it like this:
It’s like tailoring a suit instead of buying a ready-made one. The two parties agree on the size, style, price, and rules — all customized.
Key Features of OTC Options
- Not traded on stock exchanges
- Flexible terms – you decide expiry date, price, and type
- Mostly used by institutions, not retail investors
- Higher risk – no regulator like SEBI to monitor every deal
- Privately negotiated – often done via brokers or directly
Types of OTC Options
- Call Option
The buyer gets the right to buy an asset at a fixed price in the future. - Put Option
The buyer gets the right to sell an asset at a fixed price in the future. - Exotic Options
These are advanced, customized contracts like barrier options or digital options. They’re mostly used by experts and companies with unique needs.
Benefits of OTC Options
- Flexibility
You can set your own rules — expiry date, strike price, and more. - Tailored Hedging
Useful for businesses to protect against specific risks (like currency or commodity price changes). - Wider Choices
You’re not limited to the standard types offered by exchanges. - Confidential
Since deals are private, they remain off the public radar.
Real-Life Example:
A sugar exporter in India is worried that the price of sugar might fall.
They create an OTC put option with a bank, allowing them to sell sugar at a fixed price, even if market prices fall.
This protects their earnings – like a safety net.
Risks of OTC Options
- Counterparty risk – The other party might not keep their promise.
- Lack of transparency – No public data or price discovery.
- Low liquidity – Harder to exit or sell the contract before expiry.
Who Uses OTC Options?
- Large corporations
- Financial institutions
- Exporters and importers
- Commodity traders
- Hedge funds
Conclusion
Over-the-Counter (OTC) options are private, flexible, and powerful tools used mostly by professionals to manage risks or make custom financial bets. While they offer more freedom than exchange-traded options, they also carry higher risk and complexity.
