Dealer options are over the counter options that are traded between private parties, rather than through any type of public exchange. Options of this type are often traded between institutions, including governments, but can also involve a trade between an individual investor and some type of institution. It is not unusual for options of this type to involve mortgage-backed securities or some type of physical commodities.
While dealer options are not traded on any type of public exchange, they are often subject to the same kind of exchange regulations. For example, there is still the need to set the price for the transaction, document the transfer of the ownership to the investor, and assign rights to hold or sell the option once the transaction is completed. Since dealer options can also involve a combination of put and call options, it is important to make sure that the structure of the transaction is in compliance with any standards set by the agencies that regulate investment trading in the country where the trade takes place.
It is possible to earn a significant return from dealer options. Since options put together for the consideration of larger institutions usually include a number of assets, the amount of money that changes hands between the buyer and the seller can be considerable. At the same time, the volatility of the investment, especially when involving mortgages as the underlying asset for the options, can be relatively low, thus providing the buyer with a good chance of making a great deal of money from the venture. Options of this type may be intended for holding in the portfolio for a relatively long period of time, or may be held for a year or less before being traded once again, depending on the particular strategy that is employed by the investor.
It is important to note that even though dealer options are not traded on a public exchange, that does not mean they are inherently inferior or not as well researched and documented as other types of investment activity. In fact, dealers tend to place a great deal of emphasis on knowing all there is to know about options of this type, since the reputation of the dealer is especially impacted by the performance of this class of options. Should a dealer provide poor advice on the options, there is a good chance that clients will look elsewhere, especially if there is reason to believe that the dealer should have been aware of factors that led to the lackluster performance of the options.
