A non-equity option is an option with an underlying asset that is something other than common stock. In most cases, non-equity options include indexes and commodities as underlying assets. It’s really a broad term to define a variety of options, provided the option doesn’t involve common stocks.
Non-equity options usually trade over-the-counter (OTC) and come with a specific date on which they can be exercised.
Trading options over-the-counter (OTC) affords the parties involved a lot of freedom. It is a private transaction, with a contract that meets the specifications of only the parties involved. No disclosure agreement exists. The terms for trading in such a way are endless and based entirely on the wants and needs of the individuals trading with one another.
OTC trading is appealing for several reasons. It’s done privately, with all negotiations, deals, and agreements being conducted between the parties involved. As long as both sides can eventually come to an agreement that suits all needs, there is the potential for great deals and significant profit once exercised.
The biggest issue with OTC trading of non-equity options is that it’s difficult to maintain liquidity. Options can’t always be closed out by selling them to someone else before the date of expiration. When traded OTC, one of the parties involved must find a different party to create an opposing contract with. It would then offset the initial contract/position and boost liquidity.
Functions of Non-Equity Options
Non-equity options are often sought out because of the factors mentioned in the section above. However, they’re also ideal for many investors because of how they function.
One of the most important functions that a non-equity option can fulfill is allowing an investor to hedge against price movements, thereby eliminating risk. The investor may be trading a number of other positions on exchanges and use the option to offset any losses that such investments may incur.
Non-equity options make sense because by helping an investor hedge against risk; they enable him to keep a well-balanced portfolio. He enjoys more freedom to execute trades and take positions, knowing that if the positions rise or fall in a significant way, he can use a non-equity option to restore the balance.
Non-equity options are afforded the same strategy options as exchange-traded options. Two or more options may be used together, and simple put and call strategies are possible as well.
Many options that are traded on exchanges, including currency options and gold options. They, of course, don’t enjoy the same flexibility as non-equity options, which are traded over-the-counter. The exchange – not the parties involved – establish the terms of the contract, what the strike prices are, and when the options expire. They are why OTC non-equity options are often preferred because buyer and seller are free to negotiate every aspect of the transaction privately.