The Over the Counter (OTC
) market for derivatives is huge and vibrant. Simply put, an OTC derivative
is a contract between two counterparties, with any particular terms they care to employ. As a contrast, exchange traded options
have standardized maturities and standardized strike levels.
The use of the OTC
market allows a hedger to enter a specially tailored contract to hedge expected cash outlays. For example, an airline
may elect to purchase call option
s on the price of aviation fuel. If the price of fuel goes up, the airline can exercise the call and pocket the difference. Using this hedging strategy, the airline is insensitive to fuel price increases over a certain level. Typically, such an option would be an Asian option
to smooth out variability.