Complete Guide: What is OTC and How Do OTC Derivatives Work?

Many retail investors are still unaware of what OTC trading really means, although they may have already participated in this type of transaction unknowingly. OTC trading, also known as over-the-counter trading, has become an increasingly popular alternative in digital markets due to its faster execution and significantly lower fees compared to traditional stock trading.

Decades ago, individual investors had limited options for investing in stocks or commodities: they had to rely on bank intermediaries or investment groups, which meant giving up control over their decisions and paying high commissions. OTC trading has transformed this landscape, democratizing access to global financial markets and allowing anyone to invest more directly and economically.

What exactly does OTC mean?

OTC stands for ‘Over The Counter’, and encompasses all financial operations conducted outside centralized stock markets. Essentially, OTC trading is executed directly between the involved parties, without the intervention of a traditional exchange or stock market.

To understand this concept simply, consider the foreign exchange market. At first glance, exchanges and brokers may seem similar, but they operate with fundamentally different mechanisms:

Centralized trading: On an exchange, the platform acts as an intermediary, connecting sellers with buyers and organizing the transaction in exchange for a commission. When you buy currencies on an exchange, you are not trading with the platform itself, but with another user. The exchange only facilitates the operation.

OTC trading: A broker, on the other hand, buys currencies with their own capital and sells directly to the investor. In this case, you are trading directly with the financial entity, not with other users. The broker acts as the counterparty in the transaction.

This fundamental difference makes OTC trading more agile and direct, which in turn makes it more economical. By eliminating additional intermediaries, it facilitates access to global markets with a lower entry threshold for retail users.

Main OTC investment instruments

OTC markets offer multiple investment options, each with different characteristics and risks. Below, we explore the most commonly used instruments:

Contracts for Difference (CFDs)

CFDs are probably the most widespread OTC derivative in the current industry. Investing in CFDs involves agreeing with a broker to exchange the price difference of a specific position across various markets: stocks, currencies, commodities, among others.

The operation is simple: the broker will pay you the price difference between the opening and closing of your position if the price increases. If the price falls, you will be the one paying this difference. In practice, it replicates the performance of a real buy-sell operation, but with substantially lower commissions. This is especially useful for small-volume operations that would otherwise be uneconomical in traditional markets.

Options

Options allow you to acquire an asset at a specific price on a future date. If, upon reaching that date, the price is not favorable to your interest, you lose the amount deposited as collateral. Otherwise, you can buy the asset at a lower price than the market, generating a profit.

Options are popular because they provide access to purchase prices that would otherwise be unavailable in conventional markets. However, as with these complex instruments, they carry considerable risks that must be carefully evaluated.

Spot Forex

Spot forex trading represents the direct exchange of currencies between two parties. When you travel abroad and exchange currencies at a local exchange office, you are executing a Spot Forex transaction.

This type of operation is increasingly conducted through OTC channels because brokers find it more efficient to buy and sell currencies directly. Instead of charging commissions for intermediaries, currency providers mainly generate their profits through the spread (the difference between the buy and sell price).

Swaps

Swaps are agreements between companies or large investment groups where different cash flows are exchanged to manage risks or improve profit margins. They are frequently used in credit operations to stabilize earnings derived from these.

The most typical example is the exchange of credit flows between fixed and variable interest rates. In this way, a company with fixed-rate credits can increase its profits, while another with variable rates can reduce its exposure to risk.

Private stock sales

Private stock transactions also constitute a form of OTC trading and have been common practice for decades. These operations do not appear on public exchanges, making media tracking difficult.

This modality allows avoiding intermediaries and their respective commissions, offering more competitive prices than stock markets. Additionally, parallel agreements can be incorporated that add future obligations to the transaction.

Cryptocurrencies

By nature, cryptocurrencies are decentralized assets that allow buying and selling without mediation from conventional financial entities. In practice, they are usually traded through OTC brokers, although they can also be exchanged on decentralized exchanges.

Bitcoin, Ethereum, Litecoin, Tether and other cryptocurrencies are available on trusted OTC platforms, allowing investors to participate in one of the most dynamic markets with reduced spreads.

Advantages of OTC trading today

Different OTC trading modalities are utilized by various investor profiles according to their specific needs. While swaps mainly benefit large corporations, spot forex trading and CFDs are especially relevant for retail investors.

Accessibility for individual investors

Millions of retail investors worldwide have adopted OTC trading to maximize their savings and generate consistent profits. OTC trading allows for agile investment in CFDs, with low initial amounts and without excessive restrictions, transforming how everyday investors access global markets.

Significantly lower commissions

OTC trading features considerably lower commissions than centralized trading platforms and traditional stock exchanges. This advantage is substantial because it enables profits even in smaller-scale operations, which would be unprofitable with higher commissions.

Faster execution

The ability to perform smaller transactions economically allows increasing the frequency of trades. Many investors take advantage of this to open and close positions continuously, accumulating incremental gains that multiply over time. With lower risk per operation, the likelihood of making profits increases significantly.

Margin operations

Experienced investors leverage margin trading in OTC markets to boost their gains. By trading directly with a broker, OTC trading facilitates the use of leverage, allowing the opening of much larger positions using the broker’s capital. This way, profits are multiplied without the need to invest additional capital.

Key differences between OTC trading and traditional trading

The fundamental distinction lies in the role of the intermediary. Traditional trading requires public centralized platforms, while OTC trading does not.

While stock markets are more suitable for large purchases of stocks or commodities by companies and institutional investors, OTC markets offer greater agility and flexibility, making them ideal for small investors.

Trusted OTC platforms enable quick operations in stock markets, commodities, cryptocurrencies, or currencies, regardless of volume. Any individual can invest in various assets with low initial amounts, opening and closing positions as needed, and continuously reinvesting profits. This would simply not be possible on a traditional stock exchange.

Security and regulation in OTC trading

There is a mistaken perception that OTC trading is equivalent to unregulated trading. This is not correct. Although these are transactions between two parties — typically an individual and a broker — OTC trading is subject to the same regulations as traditional stock trading.

The capital of investors trading CFDs or Spot Forex is protected according to current regulations. Regardless of whether you invest in OTC or centralized markets, the key is to choose verified and regulated partners.

Criteria for choosing a reliable broker

Always work with properly regulated platforms that have proven industry experience and demonstrate legitimacy through verifiable licenses from recognized financial authorities.

Protect your account security

Your responsibility includes maintaining your account’s security. Set complex and unique passwords, and enable two-factor authentication. These essential steps protect your funds from unauthorized access.

Prudent risk management

Use automatic orders configured when opening positions to protect them if the market moves against your expectations. Remember that diversifying your portfolio is essential to maximize gains and minimize potential losses.

Conclusion: The future of accessible trading

Thanks to OTC trading, investing has shifted from being an exclusive privilege of a few to becoming an activity accessible to anyone. With over-the-counter trading, you gain full control over your assets, pay reduced commissions, and leverage margin trading to multiply profits.

OTC trading democratizes access to the global financial market, offering investors full control over their capital and operations, with adequate liquidity and generous terms that facilitate opening positions of various sizes. This transformation continues to attract new investors seeking greater autonomy and profitability in their financial operations.