Over-the-counter (OTC) is a market where dealers trade securities directly with each other, rather than through traditional broker or centralized exchange. The OTC market is made up of a network of dealers who agree to trade with each other.
This type of market typically has less regulation and transparency than centralized exchanges, which can lead to more volatility. This includes stocks, bonds, and derivatives. OTC securities are typically traded between institutional investors and/or high net worth individuals.
Over-the-counter markets are typically used for more illiquid or less transparent securities, such as private company stock, bonds, and derivatives. The largest over-the-counter market in the world is the foreign exchange market, where trillions of dollars of currency transactions take place every day.
The OTC market has been around for centuries in one form or another, but it came into its own during the 1990s when electronic trading systems allowed investors to buy and sell stocks anonymously, bypassing the traditional brokers. Today, most major stocks and bonds are traded over-the-counter.
What Is Over-the-Counter (OTC) in the financial industry?
An over-the-counter (OTC) security is a security that is not listed on a formal exchange, such as the New York Stock Exchange or the NASDAQ. OTC securities are traded directly between investors, typically through a dealer network. Because there is no centralized exchange for OTC securities, their prices can be more volatile than those of listed securities.
Types of OTC markets
There are two types of OTC markets: dealer networks and interdealer markets:
- Dealer network: investors deal directly with brokers who match buyers and sellers.
- Interdealer market: investors trade through intermediaries known as dealers.
OTC Derivatives: Types and Features
OTC derivatives are a type of security that is traded in the over-the-counter market.
There are two types of OTC derivatives: Forwards and swaps:
- Forwards are contracts that obligate the parties to exchange assets at a future date.
- Swaps are contracts that allow the parties to exchange payments over time.
The features of OTC derivatives vary depending on the type of contract:
- Forwards generally have delivery dates and expiration dates.
- Swaps can have a variety of features, including payment schedules, notional amounts, and settlement procedures.
How to buy a Securities on OTC Market?
When buying a security on the OTC market, there are a few things you need to know.
- Firstly, you need to find a broker who deals in OTC securities.
- Then you need to decide what type of security you want to purchase.
- Finally, you need to agree on the price and terms of the sale with the broker.
The OTC market can be a great place to invest in smaller companies or securities that are not available on major exchanges. However, it can also be more risky than investing through traditional channels.
Advantages of OTC markets
There are several advantages to investing in OTC securities:
- OTC products are a great way for speculative investors to get into the penny stock market with a smaller investment.
- Many times, OTC products offer the same features as their more expensive counterparts on the exchanges.
- There is no central exchange for these securities, prices can be more flexible and better reflect the true market value (or not, due to high financial spreads).
Disadvantages of OTC market
There are a few key disadvantages to using OTC products when it comes to finance and investments:
- OTC products are not regulated as tightly as stocks or other traditional investment vehicles, there is a greater potential for fraud and scams.
- They are not as well-known or widely traded as other investment options, OTC products can be more difficult to sell or trade when needed.
- They offer less liquidity than most alternative investment vehicles. This means that they can’t be sold quickly and they often have much wider spreads.
- The prices of OTC products can be more volatile and unpredictable than those of more established investment options.
> Learn more about volatility in stock markets.