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What Are OTC (Over-the-Counter) Securities?

OTC (over-the-counter) securities are securities that trade via a broker-dealer network instead of on major exchanges like the NYSE. OTC securities can include stocks, bonds, and derivatives (contracts that derive value from an underlying asset). 

OTC securities, explained

OTC securities are assets that trade between parties without listing on an exchange. The OTC marketplace allows small companies and firms that can’t or don’t meet strict exchange requirements to issue securities.

With often-cheap buy-in prices and the potential to see rapid gains, OTC securities seem promising. However, OTC markets are famous for low liquidity, high volatility, and less financial transparency and regulation. As such, they pose greater risk of fraud and market manipulation. 

Securities that trade OTC

Over 10,000 securities trade OTC, including stocks, bonds, commodities, and derivatives. 

For some securities, like corporate bonds, the OTC market is the default “exchange,” as issuers can bypass hefty listing fees. (Listing on the NYSE alone can cost $295,000.) It’s also a viable marketplace for companies that can’t or don’t meet listing requirements like trade volumes, number of shareholders or financial reporting standards. 

Some firms remain unlisted by choice or use OTC securities to quickly access capital. Others, like American Depository Receipts (ADRs), represent shares in foreign companies that don’t meet U.S. standards. 

Trading OTC securities

OTC securities generally trade on electronic interdealer quotation systems called Alternative Trading Systems. Market makers and broker-dealers rely on ATSs to publish OTC bid and ask prices.  

Each ATS sets its own eligibility standards: while some require regular financial reports to the SEC, others hold laxer standards. OTC Markets, the largest OTC marketplace, groups investments based on the quality and quantity of information available:

  • Best Market (OTCQX) securities must remain current on regulatory disclosures and financial audits. They trade for $5 minimum and can’t be in bankruptcy.  
  • Venture Market (OTCQB) securities are issued by early-stage and growth companies with a $0.01 minimum bid price. They must remain current on regulatory reporting, maintain GAAP standards and can’t be in bankruptcy. 
  • Pink Open Market (“Pink Sheets”) securities have no minimum reporting or financial standards and may include penny stocks and shell corporations. Pink Sheets is the riskiest OTC market and poses the greatest risk of fraud. 

Trading OTC securities

Unlike the NYSE, OTC markets don’t have a physical location. But for most investors, buying OTC securities is no different than trading listed stocks. 

Generally, you can buy OTC securities through most major brokers online or over the phone. However, your broker may set higher fees or trading restrictions. For instance, many limit OTC trading hours or require limit orders to minimize the risk of closing at undesirable prices. 

Brokers set these limits to minimize the risks of OTC market volatility. And the higher fees can encourage OTC market makers to carry a robust inventory to facilitate trading. 

What this means for you

OTC securities are popular with some investors due to their potential for quick gains, as well as their wide range of investments. 

However, OTC markets may have a higher risk of fraud, as well as lower liquidity, and higher volatility than major exchanges. And while some companies do file reports with the SEC, many don’t, leaving you with less information to make informed trading decisions. 

As such, we generally advise that investors leave OTC trading to the pros. (Or at least, thoroughly research any OTC securities before purchase.) 

Disclosures

Q.ai is the trade name of Quantalytics Holdings, LLC. Q.ai, LLC is a wholly-owned subsidiary of Quantalytics Holdings, LLC ("Quantalytics"). Quantalytics offers automated financial advice tools through Quantalytics Investment Advisors, LLC ("QAI"), an SEC-registered investment advisor. QIA’s investment advisory services are ONLY available only to residents of the United States. Disclosures concerning QIA’s investment advisory services are available on its Form ADV filed with the SEC. The content in this newsletter is for informational purposes only and does not constitute a comprehensive description of Q.ai's investment advisory services.

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