Chapter 1 Overview
Over-the-Counter Equity Option refers to a stock option in which terms such as the exercise price and exercise date are determined through negotiation by both parties to the transaction according to their own needs and wishes. Different from standardized options traded on exchanges, the contract content of OTC individual stock options can be customized according to the needs of both parties to the transaction.
OTC individual stock options are generally provided by financial institutions as trading platforms, and the trading targets are mainly large institutional investors and high-net-worth individual investors. Compared with standardized options, its transaction process is more complicated, including inquiry, quotation, negotiation, transaction, settlement and other links, and the risks involved are also more complicated and diverse.
The trading risks of OTC individual stock options mainly come from uncertainties in market fluctuations, exercise direction, exercise time, etc. Therefore, both parties to the transaction need to have high risk awareness and risk management capabilities. At the same time, the contract content of OTC individual stock options is relatively flexible, and both parties to the transaction can design according to their own needs and expectations. Therefore, for investors who can accurately grasp market trends and risks, OTC individual stock options can provide more flexible and diverse options. customized investment options.
As a high-risk and high-reward financial derivative, OTC individual stock options have the following characteristics:
- Non-standardization: The contract content of OTC individual stock options is different from that of exchange standardized options contracts. Both parties to the transaction can formulate terms according to their own needs and wishes, making the contract content more flexible and diverse.
- Customization: The trading objects of OTC individual stock options are mainly large institutional investors and high-net-worth individual investors. Both parties to the transaction can design contracts according to their own needs and expectations to achieve more customized investment strategies.
- Risk management: Both parties to OTC individual stock options transactions need to have high risk awareness and risk management capabilities to deal with uncertain risks in terms of market fluctuations, exercise direction, and exercise time.
- High leverage: Over-the-counter individual stock option trading can use the leverage effect, so that investors can obtain higher returns with a smaller capital investment.
- High threshold: The transaction threshold of OTC individual stock options is relatively high, which generally requires relatively high transaction volume and rich investment experience and knowledge, and is suitable for investors with a certain investment background in the financial market to participate.
Generally speaking, the trading methods of off-exchange individual stock options are more flexible and diversified than standardized options on exchanges, and investors can formulate contract terms according to their own needs and wishes. However, the trading risk of off-market individual stock options is also higher, requiring investors to have higher risk awareness and risk management capabilities to cope with the uncertain risks of the market.
According to the option type and exercise method, the OTC individual stock options can be classified as follows:
According to the type of options, OTC individual stock options can be divided into call options and put options. A call option means that the option holder has the right to buy the underlying stock at a certain time in the future at a negotiated price, while a put option means that the option holder has the right to sell at a certain time in the future at a negotiated price underlying stock. Call options and put options can be used to hedge market risks, increase leverage, and obtain income, etc.
According to the exercise method, OTC individual stock options can be divided into European options and American options. European options mean that the option holder can only exercise the option on the expiration date, while American options mean that the option holder can exercise the option at any time before the expiration date. Compared with European options, American options have higher flexibility and value, so their prices are relatively higher.
In addition, over-the-counter individual stock options can also be classified according to factors such as option expiration date, underlying asset, and exercise price. Different types of over-the-counter individual stock options have different characteristics and application scenarios, and investors should choose according to their own investment goals and risk tolerance.
In China, the market size of OTC individual stock options is relatively small. Compared with the market size of exchange-traded options, the trading volume of OTC individual stock options is also relatively limited. Over-the-counter individual stock option transactions are mainly conducted between financial institutions and large enterprises. With the continuous development of China's financial market and the gradual improvement of the understanding of financial derivatives, OTC individual stock option trading has gradually become an important tool for some institutional investors and enterprises.
However, due to the relatively strict supervision of China's financial market, the trading of OTC individual stock options still faces some restrictions. For example, at present, only institutional investors who meet certain conditions can participate in off-exchange individual stock option transactions, while individual investors cannot participate in off-exchange individual stock option transactions for the time being.
According to relevant statistics, as of 2021, China's over-the-counter options market includes different types of options such as stocks, indexes, and futures, and over-the-counter individual stock options account for a relatively small proportion. Although it is still relatively small compared to the market size of exchange-traded options, the trading volume of OTC individual stock options has increased year by year, indicating that the market demand for OTC individual stock options is constantly increasing.
Figure securities company OTC option underlying
Source: Asset Information Network Qianji Investment Bank iFinD Huaneng Securities
Chapter 2 Business Model and Technology Development
2.1 Business model
The business model of OTC individual stock options can be divided into two types:
(1) Trader model
OTC individual stock option traders, as financial institutions, earn income by providing off-exchange individual stock option trading services. The dealer model usually requires high capital strength and a professional trading team, which can provide high-quality trading services and excellent customer experience.
In the dealer mode, dealers sign transaction agreements with investors to provide individual stock option trading services. Investors can buy and sell individual stock options on the trading platform provided by the dealer by paying certain fees such as commission and margin to the dealer. The dealer quotes the price of the option contract according to the needs of investors, and matches the transaction between the two parties on the trading platform. After the transaction is successful, the dealer conducts settlement and liquidation according to the transaction result.
(2) Trading platform mode
OTC individual stock option trading platforms charge commissions and other fees by providing trading platforms. Compared with the dealer model, the trading platform model is more asset-light and flexible, and can better meet the rapidly changing needs of the market.
In the trading platform mode, the trading platform provides investors with a trading platform and technical support, and investors trade individual stock options through the trading platform. The trading platform provides quotations, matching transactions, settlement and clearing and other services, and charges certain commissions and other fees. Investors need to pay a certain margin and transaction fees. The trading platform does not directly participate in buying and selling, but only provides technical and service support. At the same time, it needs to abide by relevant laws, regulations and regulatory requirements to ensure fair and transparent transactions.
Whether it is a dealer model or a trading platform model, the core of the OTC stock options business model is to provide trading services and earn income by charging commissions and other fees. However, the implementation methods and operating mechanisms of the two models are slightly different, and investors can also choose a trading method that suits them according to their own needs.
2.2 Profit Model
(1) Trading commissions: traders or trading platforms charge commissions for providing off-exchange individual stock options trading services, usually a certain percentage of the transaction amount. This part of the income is one of the main sources of income for off-market individual stock options.
(2) Interest income: In the management of margin, traders or trading platforms can deposit investors' margin in banks or other financial institutions to obtain interest income. This part of the income is also an important source of income for off-market individual stock options.
(3) Risk control: In order to ensure the safety and stability of transactions, traders or trading platforms need to establish risk control systems and fund management systems to carry out risk monitoring and fund management, so as to avoid transaction defaults and losses. At the same time, traders or trading platforms can also reduce their own risks and losses through risk control and fund management.
In addition to the above profit model, traders or trading platforms can also increase revenue by providing other value-added services, such as providing analysis reports, data analysis, financial consulting and other services, which usually charge a certain fee.
In general, the profit model of OTC individual stock options is mainly based on providing transaction services and fund management, and earning income by collecting commissions, interest income and other value-added services. At the same time, in order to ensure the safety and stability of transactions, traders or trading platforms need to establish a sound risk control system and capital management system to avoid losses and defaults.
2.3 Influencing factors
(1) Market volatility: The increase in market volatility will increase investors' risk perception and risk management needs, which will prompt investors to use more OTC individual stock options to manage risks.
(2) Price volatility: An increase in market volatility usually leads to an increase in the volatility of stock prices, which will increase the trading demand for OTC individual stock options. For investors, the greater the price volatility, the more likely to obtain high returns, but it also means higher risks.
(3) Trading liquidity: Market volatility has an impact on the liquidity and price of OTC individual stock options trading. Increased market volatility may reduce the liquidity of over-the-counter individual stock options, causing trading prices to become more uncertain.
(4) Transaction costs: The increase in market volatility may lead to an increase in the transaction costs of OTC individual stock options, because traders may need to bear higher risk premium costs to buy or sell option contracts.
(5) Market sentiment: Market sentiment usually refers to investors' overall sentiment and expectations of the market, including views on economic, political and financial events. The quality of market sentiment will directly affect the stock price and the price of OTC individual stock options. Investors' expectations and risks for the future will lead to changes in the trading volume and price of OTC individual stock options.
(6) Time value: Time value refers to the value other than the intrinsic value in the price of off-market individual stock options, and it is also one of the most important factors in off-market individual stock option transactions. As time goes by, the time value of OTC individual stock options will continue to decrease, so the price of OTC individual stock options will also decrease accordingly.
(7) Interest rate: Interest rate is one of the important factors in the price of over-the-counter individual stock options. If interest rates rise, the price of off-market individual stock options will also rise, because investors can obtain higher profits; conversely, a decline in interest rates will lead to a decline in the price of off-market individual stock options.
(8) Policies and regulations: Policies and regulations are also very important to the supervision and development of the OTC individual stock options market. Policies and regulations include financial regulatory policies, securities market regulatory policies, tax policies, etc. The formulation and implementation of these policies may affect the market size, investor participation, and transaction costs of OTC individual stock option transactions.
2.4 Technology Development
The possible technical development direction of OTC individual stock option business:
(1) Electronic trading platform: Traditional over-the-counter individual stock option trading usually requires investors to trade through brokers or exchanges, but with the emergence of electronic trading platforms, investors can directly participate in transactions through the Internet. The electronic trading platform has the advantages of convenient trading and information disclosure, which makes the trading of off-site individual stock options more popular and convenient.
(2) Risk management technology: Risk management is one of the keys to over-the-counter individual stock options trading, and is crucial to market stability and investor protection. Modern risk management technology can provide more comprehensive and efficient risk control means, such as risk control system, risk assessment tools, regulatory technology, etc., to provide investors with a safer trading environment.
(3) Artificial intelligence technology: Artificial intelligence technology can conduct in-depth analysis and prediction of off-market individual stock option transaction data to help investors make more accurate decisions and transactions. For example, use natural language processing technology to analyze information such as news reports and social media, identify market impacts and trends, and provide reference for investors' trading decisions.
(4) Blockchain technology: Blockchain technology can provide a more secure and transparent OTC stock options trading environment. Through blockchain technology, transaction records can be publicly recorded, verified and tracked, avoiding fraud and manipulation, while improving the speed and efficiency of transactions.
(5) Quantitative trading technology: Quantitative trading technology is a technology that uses algorithms and mathematical models to analyze market conditions and transaction data, and automatically conduct trading decisions and trading operations. Quantitative trading technology can improve the efficiency and accuracy of transactions, reduce transaction costs and risks, and has wide application and development prospects for OTC individual stock option transactions.
The continuous development and application of over-the-counter individual stock option technology has provided investors with more and richer trading methods and tools, and at the same time improved the stability and transparency of the market.
2.4 Policy Supervision
Industry authorities and management system
The supervision and management system of over-the-counter individual stock options is the responsibility of the China Securities Regulatory Commission ("CSRC") and its authorized exchanges or institutions.
Specifically, the China Securities Regulatory Commission is responsible for formulating and promulgating relevant regulations and policies on OTC individual stock options, and supervising and managing the operation of the OTC individual stock option market. At present, the OTC individual stock options market in China is mainly operated by the China Financial Futures Exchange and the Shanghai International Energy Exchange.
In addition, the Securities Commission of the State Council, the China Banking and Insurance Regulatory Commission and other departments have also participated in the supervision and management of OTC stock options.
related policy
"Over-the-Counter Derivatives Trading Pilot Management Measures": It is one of the main regulatory documents for the OTC individual stock options market. The Measures provide detailed regulations on the trading subject, trading system, and risk management of OTC individual stock options.
"Guiding Opinions on Promoting the Healthy Development of the Futures and Options Market": This document clearly proposes policies to support OTC individual stock options, including exploring and developing OTC option varieties such as stock index options, individual stock options, and commodity options, and actively carrying out pilot projects in the OTC option market , Improve the policy support for OTC options market infrastructure and other aspects.
"Several Opinions on Further Supporting the Healthy Development of the Futures Market": This document clearly puts forward policies to strengthen the supervision of OTC options and support the development of OTC options. Specific measures include strengthening market supervision and risk prevention, establishing and improving the infrastructure of the OTC options market, and expanding policy support for participants in the OTC options market.
"Notice of the China Securities Regulatory Commission on Launching the Pilot Program of Individual Stock Options": This document clearly puts forward the specific requirements and procedures for launching the pilot program of individual stock options, and puts forward relevant requirements for the compliant operation of OTC individual stock options, which further promotes the development of OTC stock options. The development of the stock options market.
"Guiding Opinions on Reforming and Improving the Basic System of the Securities Market": This document proposes measures to further improve the basic system of the securities market and develop the derivatives market, including further expanding the scale of the OTC options market and improving the regulatory mechanism for the OTC options market. policy support.
"Notice on Regulating the Order of the OTC Options Market": This document clearly requires participants in the OTC options market to operate in accordance with laws and regulations, standardize market order, strengthen market supervision and risk prevention, and establish and improve OTC options market risk management and risk monitoring Mechanisms and other aspects of policy support.
In addition, in order to support the innovation and development of over-the-counter individual stock options, the national and local governments have also issued a number of related policies, such as optimizing tax policies and increasing financial support, etc., providing strong support for the healthy development of the OTC individual stock options market. Assure.
Figure Relevant laws and regulations of OTC options industry
Source Asset Information Network Qianji Investment Bank IFinD Debon Securities
Chapter 3 Business Development, Driving Factors and Risk Management
3.1 Business Development
With the continuous deepening of China's financial market and the rapid development of the financial derivatives market, the OTC stock option market has also developed rapidly in recent years.
First of all, at the policy level, the Chinese government has provided strong support and guarantee for the development of the OTC individual stock option market through a series of relevant policies and regulations. The relevant policies have been introduced above.
Secondly, in terms of market demand, more and more investors are beginning to pay attention to the emerging investment variety of over-the-counter individual stock options. Compared with traditional stocks, funds and other investment products, OTC individual stock options have more flexible trading methods and more diversified investment strategies, which can better meet the different needs of investors.
In addition, the trading volume and transaction value of OTC individual stock options are also rising. According to data released by the China Financial Futures Exchange, the total trading volume of over-the-counter individual stock options will reach 1.04 trillion yuan in 2021, a year-on-year increase of 55.1%. Especially during the COVID-19 epidemic in 2020, the trading volume and trading value of OTC individual stock options have increased significantly, injecting new impetus into the development of the market.
Finally, in terms of market participation, as more and more exchanges and institutions enter the OTC individual stock options market, trading activity and market competition are gradually increasing. At present, the China Financial Futures Exchange and the Shanghai International Energy Exchange are the main trading venues in the OTC individual stock options market in China, but there are also many other institutions and exchanges that have a certain market share in the OTC individual stock options market.
To sum up, the OTC individual stock option market has developed rapidly in terms of policy, market demand, trading volume and market participation, and is expected to continue to maintain a good momentum of development in the future.
3.2 Driving factors
market competition
Competition in the OTC individual stock option market mainly focuses on two aspects:
(1) Competition between platforms: The competition among OTC individual stock option platforms is mainly manifested in technological innovation and improvement of service quality. The platform must continuously introduce new functions and services to improve user experience and meet user needs, and at the same time improve technology and security performance to ensure transaction stability and security.
(2) Competition between products: The competition among OTC individual stock option products is mainly manifested in the differentiation of price, income, liquidity and other aspects. Different products have different prices, returns and liquidity, and investors can choose different products according to their own needs and risk preferences. At the same time, the innovation of over-the-counter individual stock option products is also an important aspect of competition, such as launching new contract types and adjusting trading rules.
investor needs
(1) Risk management: Off-market individual stock options can be used to reduce the risk in the investment portfolio, thereby improving the efficiency of the overall investment portfolio.
(2) Leverage effect: OTC individual stock options are a highly leveraged product that can bring higher returns and attract investors who pursue high returns.
(3) Speculative demand: OTC individual stock options can be used for short-term speculation to obtain short-term high returns.
(4) Diversified needs: OTC individual stock options provide a variety of trading strategies, and investors can choose different trading strategies according to their own risk preferences and investment goals.
(5) Demand for fixed income: Some off-market individual stock option products can provide stable income, so they also attract some investors who seek stable income.
skill improved
(1) With the continuous advancement of technology, OTC individual stock option trading is also constantly undergoing technological innovation and improvement. The following are some specific manifestations of technological progress:
(2) Trading system: The over-the-counter individual stock option trading system adopts an efficient, stable and safe trading system to realize high-speed and automatic trading. In the design and development process of the trading system, advanced technologies such as cloud computing, big data, artificial intelligence, etc. are also adopted.
(3) Mobile terminal trading: More and more off-exchange individual stock option trading platforms have begun to provide mobile terminal trading services, allowing investors to conduct transactions anytime and anywhere, which is convenient and fast.
(4) Trading tools: The OTC individual stock option trading platform provides more trading tools, such as market analysis, technical indicators, strategy simulation, etc., to provide investors with more comprehensive trading support.
(5) Risk control: The over-the-counter individual stock options trading platform adopts more stringent risk control measures, such as risk control indicators, risk management tools, etc., to fundamentally avoid transaction risks.
international market
The influence of the international market on OTC individual stock option trading mainly comes from two aspects: the market environment of the international market and the competition in the international market.
First of all, the market environment of the international market will have an impact on OTC individual stock options trading. Since OTC individual stock option trading is conducted in a globalized market, political, economic and financial events around the world may have a significant impact on transactions. For example, events such as the U.S. presidential election and the debt crisis in the euro zone may cause fluctuations in the international market, which in turn will affect the OTC individual stock options trading market.
Secondly, the competition in the international market will also have an impact on the OTC individual stock options trading market. At present, a certain scale of over-the-counter individual stock option trading markets has been formed around the world. Among them, the OTC individual stock option trading markets in the United States, Europe, Japan and other countries are relatively large in scale, with many market participants and high market activity. Therefore, competition in the international market will prompt the domestic OTC individual stock option trading market to improve its service level and competitiveness.
In addition, the development of the international market also provides a reference for the domestic OTC individual stock option trading. For example, the experience and practices in product design, trading system, risk management, etc. in the international market can provide inspiration and reference for the development of the domestic OTC individual stock options trading market.
3.3 Risk Management
Table common industry risk factors
Source: Asset Information Network Qianji Investment Bank
As a financial derivative transaction, OTC individual stock option trading has certain risks. The following is an analysis of some possible risk factors:
- Market risk: The transaction price of OTC individual stock options is affected by various factors such as stock price fluctuations and market sentiment, and market risk is inevitable.
- Hedging risk: In over-the-counter individual stock options trading, investors often use stock options to hedge, but the price of stock options will also fluctuate, and hedging risks need to be paid attention to.
- Liquidity risk: The liquidity of the OTC individual stock option market is low, with few trading varieties, small trading volume, and large bid-ask spreads. When there is an abnormality in the market, the transaction may be restricted or cannot be carried out smoothly.
- Market transparency risk: OTC individual stock options trading lacks an open and transparent trading market, and the risk of information asymmetry may increase.
- Legal and regulatory risks: At present, my country's individual stock option trading market regulatory system and laws and regulations are not yet fully mature, and investors need to pay special attention to compliance risks.
- Counterparty risk: In over-the-counter individual stock option transactions, the counterparty may have the risk of default or failure to perform the contract.
- Operational risk: Over-the-counter individual stock option trading requires investors to have high experience in financial markets and financial instrument transactions. Insufficient operating experience and skills may lead to losses.
- Other risks: There are also risks such as policy risk, credit risk, and interest rate risk that investors need to pay attention to.
3.4 Competition Analysis
- Financial institutions: Financial institutions such as traditional investment banks, securities companies and futures companies are one of the main participants in the OTC stock option market. They have strong financial strength and customer resources, can provide comprehensive financial services, and have advantages in market expertise, talents and technology. However, financial institutions are also affected by factors such as regulatory constraints, cost pressures and internal organizational changes.
- Trading Platforms: OTC single stock options trading platforms are another major player in the market. They have attracted a large number of investors and traders by providing a convenient trading and settlement platform. The trading platform also provides a wealth of market data and analysis tools to help investors make more informed investment decisions. However, trading platforms also face challenges in market competition, security and legal compliance.
- Technology companies: In recent years, technology companies have also begun to enter the OTC individual stock options market. These companies usually have advanced technologies and innovative business models, such as the application of technologies such as artificial intelligence and blockchain. The entry of technology companies has made market competition more intense, but they also need to face challenges such as regulatory restrictions and financial strength.
3.5 Major Players
China
- Financial institutions: Banks, securities companies, futures companies and other financial institutions are one of the main participants in the OTC stock options market. They obtain trading commissions and other benefits by providing over-the-counter individual stock options trading services.
- Investors: including institutional investors and individual investors. Institutional investors include fund companies, insurance companies, securities investment funds, etc., they carry out portfolio risk management and hedging through off-market individual stock options; individual investors include retail investors and high-net-worth investors, they use off-market individual stock options Options earn speculative income.
- Investment consultants: Professional institutions that provide off-market individual stock option investment advice and risk management services, such as wealth management companies and investment consulting companies.
- Option trading platform: A company that provides off-exchange individual stock option trading platform services, including third-party platforms and financial institutions' own platforms. At present, the main OTC individual stock option trading platforms in China include Nanjing Securities, Huatai Securities, and GF Securities.
- Option market data and information providers: companies that provide options market data and information services for investors and trading platforms, including market data providers, information service providers, etc. For example, Wind, Oriental Fortune, Straight Flush, etc.
worldwide
In the global over-the-counter stock option market, the main participants include the Chicago Board Options Exchange (CBOE), the New York Stock Exchange (NYSE), the American Stock Exchange (NASDAQ), etc., and the London Stock Exchange (LSE) in Europe. , European Options Exchange (Eurex), etc. In addition, Asian exchanges such as Hong Kong Stock Exchange, Singapore Exchange, and Tokyo Stock Exchange have also launched related products. These exchanges are legal trading platforms approved by regulatory agencies, with mature trading systems, rules and supporting services, attracting a large number of institutional investors and individual investors to participate in transactions.
3.6 Comparison of domestic and foreign margin financing and securities lending markets
At present, the domestic OTC individual stock option market is still relatively new compared with the international market, and the market scale and development degree are relatively limited.
- Market size: The OTC individual stock option market in the international market is relatively large, with a mature market ecology and a wide range of investor groups. However, the domestic OTC individual stock option market is still in its infancy, and the market size is relatively small.
- Product categories: OTC individual stock option products in the international market are relatively rich in variety, including call options, put options, American options, European options, etc. However, there are relatively few types of domestic OTC individual stock option products, mainly call options and put options.
- Investor group: The over-the-counter individual stock option market in the international market has attracted a large number of institutional investors and individual investors, and the investor group is relatively extensive. However, the domestic OTC individual stock option market is mainly participated by institutional investors and some individual investors, and the investor group is relatively small.
- Regulatory system: The over-the-counter individual stock option market in the international market has a relatively complete regulatory system and regulatory rules, and the regulatory responsibilities of exchanges and regulatory agencies are clear. However, the domestic over-the-counter stock options market regulatory system needs to be further improved and strengthened.
Generally speaking, compared with the domestic market, the OTC individual stock option market in the international market is more mature, with more product types, a wider investor group, and a more complete regulatory system.
Figure securities company OTC option trader
Source: Asset Information Network Qianji Investment Bank iFinD Huaneng Securities
Figure Current List of OTC Options Traders
Source: Asset Information Network Qianji Investment Bank iFinD Debon Securities
Chapter 4 Future Outlook
The OTC individual stock option market may have the following trends:
- Increase option varieties: At present, the OTC individual stock option market mainly includes CSI 300 index options. In the future, more individual stock option varieties may be added to cover more individual stocks.
- Increase in trading varieties: In addition to option contracts, other trading varieties may be added to the OTC individual stock option market in the future, such as stock futures and option combinations.
- Institutionalized trading: With the expansion of market size and the increase of institutional investors, the OTC individual stock options market may gradually transform to an institutionalized trading model.
- Digitization of trading platforms: In the future, OTC individual stock option trading platforms may transform to digital to improve transaction efficiency and convenience.
- International transactions: With the opening up and internationalization of China's capital market, the OTC individual stock option market may be opened to the international market, attracting more international investors.
In short, the OTC individual stock options market has great potential for development in the future, but relevant laws, regulations and regulatory mechanisms need to be further improved to ensure the healthy development of the market.
Cover Photo by Mr.Autthaporn Pradidpong on Unsplash