A listed option (also called a “naked” option) is traded on the American Stock Exchange where the writer does not own the stock, futures contract, or another instrument he is writing options against.
It can be dangerous for the person who takes this risk because they have nothing to lose but their money and time because there is no underlying asset they can sell if it goes wrong. It’s all too easy for them to end up losing more than they stand to gain from selling these options.
As such, listed options are considered a less ethical way of trading securities – whereas writing covered calls entails owning the security being written about, so you have something to fall back on if everything goes south. Listed options are very different from the more common over-the-counter (OTC) options.
What are OTC options?
OTC options are traded between two parties with a pre-existing relationship, whereas listed options are traded on an exchange where anyone can participate. Listed options also have fixed expirations and standardized strike prices, meaning that there is a lot less ambiguity in trading them. Lastly, the liquidity of listed options is much higher than OTC options. Because of these reasons, listed options are typically used by more sophisticated traders who understand the risks and rewards associated with them.
Listed options vs OTC options
While some people view listed options as a more risky way to trade securities, others believe that they can provide a higher rate of return since the options are exposed to a much larger pool of investors. However, there is also a much greater chance of loss because you don’t have an underlying asset to ensure your success.
OTC are bilateral
OTC options tend to be bilateral, meaning that both parties involved in the contract know precisely what it entails and who their counterparty is. Thus, there is no need to reference any outside sources or assets to make this decision; instead, all information about these contracts resides solely between these two parties (and maybe some lawyers if the terms are ambiguous). Listed options are more like exchange-traded securities because they’re traded through exchanges that leave records of every transaction that took place on them. Because of this, all information about the contracts is available to be accessed by anyone who wants to look.
Standardized listed options
Listed options are also more standardized than OTC options because their prices are determined on an exchange through a bidding process that considers the stock price, strike price, and interest rates. These three items allow traders to predict how volatile the market will be about these options. Hence, they’re able to determine how much it should cost for them to buy or sell these securities at any given time – thus creating a standard for listed options prices.
On the other hand, since OTC options involve people who have some pre-existing relationship with each other (as opposed to being traded publicly on an exchange), the prices for these contracts can be much more ambiguous. It’s not uncommon for one party to make an offer and the other to counter-offer, continuing this back-and-forth until an agreement is met. Because of this, OTC options can sometimes be more expensive than listed options.
Another big difference between listed and OTC options is the liquidity of each type. Listed options are much more liquid because they’re traded on exchanges with many volumes. This high liquidity ensures that there will always be somebody willing to buy or sell these securities at any given time. Conversely, OTC options are only as liquid as the two parties involved in the contract -meaning there may be an extended period between when you first initiate the contract and when it’s completed.
Listed options are publicly traded securities with standard price structures, high liquidity, and standardized terms. On the other hand, OTC options are bilateral contracts that involve two parties who have a pre-existing relationship instead of being publicly traded on an exchange that keeps records of all transactions.
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