Trading Options
Options are traded on many of the major securities exchanges (listed options), as well as over the counter market.
Most individual stock options, stock index options, and futures options trade on one of the major exchanges, such as the Chicago Options Exchange or the New York Futures Exchange and so on. Listed options are traded the same way listed stocks are traded.
Each option has a bid price and an asked price, which are determined by the same factors that determine the bid and asked of any securities - supply and demand. The trading takes place at a trading post, and each option has a specialist assigned to provide liquidity and to maintain an orderly market. The premiums have minimum price moves. For example, individual stock options have the minimum premium move of 1/8 point ($12.50). Other types of options have other minimum price moves. All trades are settleed through the listed Options Clearing Corporation (OCC). By acting as an intermediary between buyers and sellers, the OCC in effect guarantees to each party that the options will be honored and that obligations incurred by all parties to options transactions will be met. Listed strike prices are set at 2 1/2 point increments (of a$100) if the price of the stock is less than $25. Strike prices are set at 5-point increments if the price of the underlying stock is between $25 and $200 per share. For the prices currently over $200 per share, strike prices are set at 10-point increments. For example, if the price of the underlying stock is currently $15, the option strike prices are $10.00, $12.50, $15.00, $17.50 and so on.
Over the counter options trade primarily on currencies and on individual bonds. Each of these options contracts is the direct result of negotiations between the buyer and the seller. They can agree on any strike price, any expiration date, and any premium that is mutually aggreable. Hence the advantage of OTC options is that the contract can be customized to meet the individual needs of the option's buyer and seller. The disadvantages are:
Getting accurate price information is very difficult and therefore, the possibility exists for either the buyer to overpay for the option or the seller to undersell it. The options, once purchased, are very hard to resell becasue no ready market exists. While listed options are generally very liquid, OTC options are not. There is no clearing house to guarantee OTC option transaction so there is a credit risk here.
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