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 options 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.