Over-the-Counter Option (OTC)

An over-the-counter (OTC) option is a contract giving one party the right, but not the obligation, to buy or sell an underlying asset at an agreed price, that is negotiated privately between two parties rather than bought and sold on a public exchange. Think of it as a custom-made agreement rather than an off-the-shelf product.

With a listed (exchange-traded) option, the exchange sets standard terms — fixed strike prices, fixed expiration dates, and a standard contract size — so that any buyer's contract is identical to any seller's contract. This is what makes those options easy to trade repeatedly: a buyer can sell to a stranger later because the contracts are interchangeable. An OTC option skips that standardization. The two parties agree on their own strike price, expiration date, contract size, and settlement terms, tailored to whatever they need.

Because OTC options are custom and privately arranged, there is no organized secondary market for them — you generally cannot resell your specific contract to a third party the way you could close out a listed option on an exchange. You are typically stuck holding the position until expiration or negotiating directly with your original counterparty to unwind it. This also means you are exposed to counterparty risk: if the person or firm on the other side of the trade cannot or will not honor the contract, there may be no clearinghouse standing behind it to guarantee payment, unlike with listed options.

The nuance beginners miss is that "OTC option" is not about the underlying stock being obscure or low-priced (that's a separate, unrelated use of "OTC" for penny stocks). It's specifically about how and where the option contract itself was created and traded — privately negotiated versus exchange-listed.