The term options refer to a broad category of derivatives contracts under which the buyer (or holder) has the right but not the obligation to buy or sell, respectively, the underlying product at a fixed price on or before a given date. These can be traded in organised exchanges called stock exchanges or over-the-counter (OTC). In the OTC options market, there is no central exchange for trading transactions, and hence they do not have uniform prices as in the case of organised exchanges.
In India, options trading is quite popular as it offers a high degree of leverage and opportunities for diversification.
Where to trade options in India
There are four stock exchanges and more than 25 MTFs in India that provide a trading facility in options. National Stock Exchange (NSE) and BSE Ltd. offer trading facilities in cash-settled and electronically traded derivatives, including currency derivative contracts, interest rates, equities based instruments and commodity futures.
Main differences between Listed options and OTC options
What are the differences between Listed options and OTC options?
Intermediaries
Sellers and buyers can negotiate directly with each other on price and terms without any intermediary like Clearing Corporation of India Limited(CCIL)
Trading hours
All listed options go through an auction process monitored by the exchange during market hours. On the other hand, trading in OTC options takes place outside of market hours.
Settlement of transaction
All listed options settle through clearinghouses like CCIL, while settlement of the transaction in case of OTC options is done based on the “Delivery versus Payment” (DVP) mechanism.
Specification
Listed options are traded in standard lot size, for which 100 shares are equivalent to one contract, while the OTC option has no specification on lot size or contracts.
Premium calculation
The premium payable on listed options is calculated according to the last traded price and time left before expiry. At the same time, there exists no such thing as a standard premium for an OTC option since it varies with every negotiation between two parties.
Margin requirement
There is no margin required on the premium paid for listed options, while margin is required in OTC options trades depending on the size of the contract.
Transferability
A listed option can be sold to any third party (to whom it is not already sold) with the seller’s permission, but an OTC option cannot be traded to anyone other than the original buyer or seller.
Liquidity
Listed options are more liquid than OTC options due to standard contracts involving high volume.
What are the effects of using Listed options vs OTC options?
Let’s look at some of the effects of using Listed options vs OTC options
Cost
Listed options offer lower costs due to the standardisation of terms and size of the contract, which leads to greater liquidity. In contrast, a higher cost is involved in OTC than that of the listed price since it has limited buyers and sellers.
Confidentiality
A listed option ensures greater confidentiality since all transactions occur during market hours through an auction process controlled by an exchange, while the OTC option provides no confidentiality and may be prone to market abuse (manipulation).
Financial Analysis
Listed options can be used as the underlying asset for financial derivatives, which leads to more significant usage of listed options than that of OTC options by traders due to availability in multiple derivative instruments like futures and swaps.
Risk Management
Risk management is possible only through listed options with standard contracts where gain/loss can be limited easily by buying/selling nearer-term contracts respectively if the market moves adversely, leading to loss.
Final verdict
While listed options are more popular than its counterpart due to the high risk involved and security etc., the OTC option is less popular but provides better liquidity, confidentiality etc., with minimum risk, thereby making it applicable only when there is no time constraint or smaller amount involved. It is recommended that beginner traders interested in options trading india use a reputable online broker from Saxo Bank.
