Options are derivative security instruments derived from underlying assets like stocks and commodities. In the UK, options can be listed or over-the-counter (OTC). Listed options are exchange-traded and have standardised terms, whereas OTC options involve two parties negotiating the contract terms. This article will discuss the differences between listed and OTC options in options trading in the UK.
One of the critical differences between listed and OTC options is that listed options are subject to regulatory oversight, whereas OTC options are not. In the UK, listed options are regulated by the Financial Conduct Authority (FCA), which sets trading and pricing transparency rules. On the other hand, OTC options fall outside FCA jurisdiction, as they involve two parties who negotiate directly among themselves.
Another difference between listed and OTC options is that both parties are anonymous and do not know each other in a listed options contract. It helps protect against one party exercising undue influence on another. However, in an OTC option contract, both counterparties know each other and must trust their ability to perform on the contract.
The exchange sets trading hours for listed options, whereas OTC options have no restrictions on when traders can trade them. Therefore, OTC options may be more flexible than listed options in terms of timing and less liquid as there is no centralised market maker to provide liquidity.
Listed option contracts are standardised by the exchange and must adhere to their rules, while OTC option contracts are custom-made and negotiated between two counterparties. The lack of standardisation makes it harder to value an OTC option contract than a listed one.
The settlement procedure for a listed option is simpler and faster than an OTC option since it is centralised and automated. On the other hand, the settlement of an OTC option must be negotiated between two parties, resulting in a longer process.
The price discovery process for listed options is transparent, as trades are recorded on the exchange’s trading system and made available to the public. It makes it easier for investors to determine fair prices than OTC options, where prices can be manipulated by one party over another.
The pricing models for listed options are standardised and publicly available, whereas traders must negotiate the pricing models for OTC options between two parties. OTC option prices can be difficult to determine without expert knowledge.
Margin requirements for a listed option are set by the exchange, while margin requirements for an OTC option must be agreed upon between two counterparties. It makes it easier to calculate margin requirements in the case of a listed option than an OTC one.
The execution price for a listed option is determined by supply and demand in the market. In contrast, the execution price for an OTC option is determined by negotiation between two parties. It gives more control over the execution price to the OTC option buyer than the listed option buyer.
Listed options have standardised margin requirements set by the exchange, while OTC option contracts do not require any initial margin. It makes it easier for traders to buy or sell listed options with less capital than they would need for an OTC option.
Traders must exercise listed options on the expiration date specified in the contract, while OTC option contracts can be exercised at any point before or after expiration. It gives OTC option holders more flexibility regarding when to exercise their options.
The settlement process for a listed option is simpler and faster than an OTC option since it is centralised and automated. On the other hand, the settlement of an OTC option must be negotiated between two parties, resulting in a longer process.
The contract sizes for listed options are standardised and determined by the exchange, while OTC option contracts can be custom-made with any agreed-upon contract size. It makes trading more significant amounts in a listed option easier than an OTC one.
The exchange regulates listed options, which provides investors with enhanced protection against fraud or manipulation. Conversely, no such regulatory oversight exists for OTC options, making them riskier than their listed counterparts.