The over-the-counter market is an important alternative to exchange and measured in terms of the total volume of trading has become much larger than the exchange-traded market.
The OTC market is a negotiated market. Transaction not handled on an organized exchange is handled in this market. The OTC market is not a place it has no central location but it is rather a way of doing business. It consists of a network of dealers, linked together by communication devices including the latest technological equipment these dealers can deal directly with each other and with the customer.
The third term market describes over-the-counter trading of shares listed on an exchange, Although most transaction inlisted stock takes place on an exchange. An investment firm that is not a member of the exchange can make a market in the listed stock. The success or failure of the third market depends on whether the OTC market in these stocks is a good as the exchange market and whether the relative cost of the OTC transaction compares favorably with the cost on the exchange.
Future exchange arose to solve some of the problems associated with over-the-counter trading of forward that had existed previously, similarly the establishment of exchange-traded options led to an explosion of trading and resulted in markets that are much larger and more robust than the over-the-counter option market that came before.
The function of the Over-the-counter market
->Dealers arrive at the prices of securities in the OTC market by both negotiating with customers specifically and making competitive bids.
->Dealers match the forces of supply and demand with each dealers making a market in certain securities.
->Dealers quote bid and ask prices for each security the bid price is the highest price offer by the dealers,and the ask price is the lowest price at which the dealers making a market in certain securities.
->Dealers quote bid and ask prices for each security,the bid price is the highest price is the lowest price at which the dealer is willing to sell
-> Actively traded stocks on the OTC market have a many us to 10 to 20 market makers(dealers functions must as the specialist does for an exchange-listed stock.
Clearing of OTC
The marketing process for OTC trades is similar to that of the exchange-traded option. After the trade occurs, the firm’s back-office its paper processing center, Confirms the details of the trade.
1)Who bought and who sold
2)Put or call
5)Quantity of option
7) Identification of traders and firms
8)The timing of the premium payment
9)If upon exercise, the long is to receive a cash payment, determined by the difference between the security’s price and the strike price.
If the two firms have a master option agreement covering all such option trades, then need not be confirmed between back office for this information is specified in the master agreement.If all information fields match the back office of the respective firms agree that the trade is good, and each sends a paper confirmation to the other.
Since an OTC trade does not take place under the auspices of an exchange, there is no third party to guarantee the financial performance of the counter-parties to the trade. This requires that each party to the trade has some knowledge of the creditworthiness of the opposite party.