The Options Clearing Corporation
Remember when Wimpy would tell Popeye, “I’ll gladly pay you Tuesday
for a hamburger today.” Did Popeye ever get paid for those burgers? In a
contract, it’s very important for each party to hold up his end of the bargain
—especially when there is money at stake. How does a trader know the
party on the other side of an option contract will in fact do that? That’s
where the Options Clearing Corporation (OCC) comes into play.
The OCC ultimately guarantees every options trade. In 2010, that was
almost 3.9 billion listed-options contracts. The OCC accomplishes this
through many clearing members. Here’s how it works: When Trader X buys
an option through a broker, the broker submits the trade information to its
clearing firm. The trader on the other side of this transaction, Trader Y, who
is probably a market maker, submits the trade to his clearing firm. The two
clearing firms (one representing Trader X’s buy, the other representing
Trader Y’s sell) each submit the trade information to the OCC, which
“matches up” the trade.
If Trader Y buys back the option to close the position, how does that
affect Trader X if he wants to exercise it? It doesn’t. The OCC, acting as an
intermediary, assigns one of its clearing members with a customer that is
short the option in question to deliver the stock to Trader X’s clearing firm,
which in turn delivers the stock to Trader X. The clearing member then
assigns one of its customers who is short the option. The clearing member
will assign the trader either randomly or first in, first out. Effectively, the
OCC is the ultimate counterparty to both the exercise and the assignment.