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Suppose I buy a derivative (option, future, swap, ...) now from some party. As specified by the derivative, sometime in the future, I will buy or sell the underlying asset of the derivative. I wonder if the party with whom I will trade for the underlying asset in the future is the same as the party from whom I buy the derivative now? In other words, if a derivative and its underlying asset are traded between the same two parties?

Thanks!

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This depends on whether the "some party" is a specific institution or individual (e.g. a bank) or a central counterparty (e.g. the Options Clearing Corporation). In the first case, the answer is yes. In the second case, the central counterparty is merely an intermediary, and derivative exercises are randomly assigned. This FAQ may help you understand.

  • Thanks! But I don't understand the second case. In such case, for example, when I buy a call option, do you mean the premium I pay to buy the option now and the difference between striking price and the market price at maturity date do not go to the same party, because the latter may go to a randomly chosen someone different from the one I buy the option from? – Tim Sep 26 '11 at 0:38
  • They are all done through the OCC. Though when you initiate a trade there is necessarily a specific party on the other end, but they are not your counterparty, the OCC is. When the option is later executed, that is assigned via the OCC (read the FAQ!). – Tal Fishman Sep 26 '11 at 1:15
  • Thanks! The FAQ is difficult for me to understand for now (maybe not in the future) because of quite a few unfamiliar terminology. Forgive my ignorance: the other party that I trade the underlying with, the party that I pay the premium of the derivative to, and the counterparty are three different concepts and may not be the same? – Tim Sep 26 '11 at 1:26
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Not necessarily. I own a stock and sell a covered call. You happen to be the party that buys that call. At some point, the stock drops and so does the price of the call. I decide that Since, in effect, I am short a call in my margin account, I've made enough profit that I'll but it back. So I put in a buy-to-close order. You, on the other hand, feel time is on your side and don't wish to sell me my call, so someone else is on the other side of that trade.

When the stock triples, and you decide to exercise your option, you are getting the stock of someone else, not me, the original seller.

In the end, the other side of these positions will likely trade far faster than you or I would be trading them. The original seller will not be on the other side of the trade when it unwinds.

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