Over The Counter Option

As a financial instrument, the option has a long history.But foreign exchange options trading first began to flourish in the 1980s, fostered by an international environment of fluctuating exchange rates, volatile markets, deregulation, and extensive financial innovation. The trading of currency options was initiated in U.S. commodity exchanges and subsequently was introduced into the over the counter market. However, options still account for only a small share of total foreign exchange trading.

An over-the-counter foreign exchange option is a bilateral contract between two parties. In contrast to the exchange traded options market (described later), in the OTC market, no clearinghouse stands between the two parties, and there is no regulatory body establishing trading rules.

Also, in contrast to the exchange traded options market, which trades in standardized contracts and amounts, for a limited number of currency pairs, and for selected maturity dates, an OTC option can be tailored to meet the special needs of an institutional investor for
particular features to satisfy its investment and hedging objectives.

But while OTC options contracts can be customized, a very large share of the OTC market consists of generic, or “plain vanilla,” options written for major currencies in standard amounts and for even dates.

OTC options are typically written for much larger amounts than exchange-traded options—an average OTC option is $30-$40 million equivalent—and a much broader range of currencies is covered. The volume of OTC options is far greater than that of exchange-traded options; indeed, the OTC market accounts for about four-fifths of the total foreign exchange options traded in the United States.