An exchange-traded option is a standardized derivative contract, traded on an exchange, that settles through a clearinghouseand is guaranteed.
Understanding Exchange-Traded Option An exchange-traded option is a standardized contract to either buy using a call optionor sell using a put option a set quantity of a specific financial product, on, or before, a pre-determined date for a pre-determined price the strike price.
Key Takeaways An exchange-traded option is a standardized derivative contract, traded on an exchange, that settles through a clearinghouse, and is guaranteed. A key feature of exchange-traded options that attract investors is that they are guaranteed by clearinghouses, such as the Options Clearing Corporation OCC.
OTC options usually tend to have customized provisions. This increased volume benefits traders by providing improved liquidity and a reduction in costs. The more traders there are for a specific options contract, the easier it is for interested buyers to identify willing sellers, and the narrower the bid-ask spread becomes.
The standardization of exchange-traded options also enables clearinghouses to guarantee that options contract buyers will be able to exercise their options — and that options option exchange or over- the- counter sellers will fulfill the obligations they take on when selling options contracts — because the clearinghouse can match any of a number of options contract buyers with any of a number of options contract sellers.
Clearinghouses can do this more easily because the terms of the contracts are all the same, making them interchangeable.
This feature greatly enhances the appeal of exchange-traded options, as it mitigates the risk involved in transacting in these types of securities. Drawbacks of Exchange-Traded Options Exchange-traded options do have one significant drawback in that since they are standardized, the investor cannot tailor them to fit their requirements exactly. However, in most cases, traders will find exchange-traded options provide a wide enough variety of strike prices and expiration dates to meet their trading needs.