What is 'Escrow Receipt'
An escrow receipt is a bank or clearing firm guarantee that an option writer has the underlying security on deposit and that the underlying security is readily available for delivery if the option is exercised. This ensures that the holder of an option will receive delivery of exercised options on time and without any issue.
This guarantee is most often utilized when a client's options account is held at a bank rather than a registered broker-dealer. The escrow receipt must be written in such a way that is acceptable to the exchange and the options clearing corporation (or similar body).
BREAKING DOWN 'Escrow Receipt'
The use of escrow accounts and receipts provides written evidence and security that the securities are available to complete the transaction.
Some institutional clients such as pensions or insurance companies maintain their assets at a custodian bank, rather than at a registered broker-dealer. An options exchange's margin rules may allow a broker-dealer to accept an escrow receipt (or escrow agreement) with respect tp short options positions, in lieu of posted cash or securities. This document must be issued by a bank and be in a form which is acceptable to the Exchange as well as the Options Clearing Corporation (OCC) in the U.S.
The escrow receipt may never be needed, since it is only guaranteeing the potential for delivery. If the short options position is never assigned, for instance if it expires out-of-the-money, then the escrow receipt will not be invoked.
Examples of Escrow Receipts
For example, an escrow receipt related to a short equity call option states that the option seller's bank promises to deliver the underlying stock to the broker-dealer in the event their customer's account (the long options position) is assigned. For a short equity put option, the bank promises to deliver cash in the amount of the equivalent short stock position.
The OCC also allows banks to write escrow receipts for short index options positions. For a short index call option, the bank promises that it will hold cash or cash equivalents, or at least one marginable equity security, or a combination of the three. The total value of the assets held by the bank must equal the aggregate underlying index value on the trade date. An escrow receipt with respect to a short index put option must be backed by cash or cash equivalents at the bank which equal the aggregate put exercise amount. The escrow receipt must also give the bank the authority to liquidate assets held under the agreement if necessary to meet an assignment.