Exchange vs. Over-The-Counter Options

Foreign exchange options can be traded either on an exchange or in the over-the-counter (OTC) market, meaning between two parties. Exchange-traded options are standardized contracts with fixed maturity dates, strike prices and contract sizes, although each trade has its own contract specifications and trading rules. OTC option conditions are much more flexible since maturity, strike price amount, etc. can be arranged before dealing.

Exchange-traded options can be summarized as such:

Currencies are quoted primarily against dollars, although recently some crosses have become available.

Strike prices are at fixed intervals and quoted in dollars or cents per unit(s) of currency.

Contract sizes are fixed.

Fixed expiry dates, generally at three month intervals.

Premium is paid up front and on the same day as the transaction.

Options are usually American style.

One key benefit of standardized contracts is that the exchange acts as the counterparty to each trade. The risk of the writer defaulting on the option is thereby reduced and anonymity between counterparties can be protected. It should be noted that the Chicago Mercantile Exchange’s (CME) currency options are options on futures rather than options on the spot currency. If a call is exercised, the buyer receives a long futures position rather than a spot position, with the opposite pertaining to the buyer of a put.

Over-The-Counter options have the following features:

Strike rates, contract sizes and maturity are all subject to negotiation. An institution can structure it own option requirements, such as enabling it to make cross rate transactions.

Maturities can run anywhere from several hours to five years.

The buyer has the direct credit risk on the writers.

Only the counterparties directly concerned know the price at which the option is dealt.

The premium is generally paid with spot value from the transaction date with delivery of the underlying instrument also usually with spot value from expiry.

Options style can be American or European, but is largely European.