Options - Credit Risk

[AndyPettitteIsGreat]

Reading 39:
Why does the long side of the option have credit risk? Aren’t all options transferred through a clearinghouse (the OCC), so there should be no credit risk.

 

[cpk123]

you have the right to buy the underlying.
you exercise the right.
what happens if the seller refuses to sell you the underlying…
and also remember not all options are not exchange traded. (to have the clearinghouse step in). even there - how does the presence of the clearinghouse provide the necessary backing that when someone who wants the underlying may not get it… bcos the seller refuses to sell it.

 

[janakisri]

The terminology should be the “Seller refuses or is unable to deliver” . The sale ( or writing ) of the option is already done at the inception, only delivery comes into doubt
CP is absolutely correct that not all options are traded through an accredited exchange. There are many banks that trade OTC options ( particularly currency or rate options ) , in this case your counterparty (i.e. the bank ) is known to you and poses a credit risk to you as the holder of the option.
For options traded thru an exchange , you don’t know who the counterparty is and you don’t have to. The exchange eliminates credit risk for the option buyers by guaranteeing the trade

 

[janakisri]

I was not correct about the terminology , CP is correct in that one too. Seller has to deliver the sale on demand by buyer. So seller has to sell. The risk that he will not sell is the credit risk in the option ( applies only if it is in the money)

 

[deriv108]

I am not sure if the enhanced derivatives products companies(EDPC) is relevant here.
EDPC is created to reduce the credit risk for the buyers of credit derivatives. On the other side, the credit risk is transferred to EDPC’s parent company – the dealer. Am I right?