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  • Difference between Exchange Traded Derivatives (ETD) and Over the Counter (OTC) Derivatives

    Exchange Traded Derivatives (ETD) vs Over the Counter (OTC) Derivatives

    Derivatives are the most widely traded instruments in financial markets. Although a lot of trading is carried out on various exchanges throughout the world you may be surprised to know that most of the derivative trades are carried off-exchange i.e. Over the Counter (OTC). Though all the derivative trades on both exchange and off it are based on the same principal of deriving value from the underlying there are differences in the products, regulations, processing etc. The following write-up could be helpful in understanding a few of these differences.

    What is the Difference between Exchange Traded Derivatives (ETD) and Over the Counter (OTC) Derivatives ?

    1. Location: – As the name states Exchange Traded Derivatives are derivatives that are traded on an exchange which is the centralized platform for carrying out all the transactions .OTC contracts on the other hand are decentralized. Market intermediaries compete to match buyers with sellers.
    2. Contracts: – The contracts traded on an exchange are standardized i.e. they cannot be customized according to one’s need.OTC contracts are private contracts that can be customized as per one’s needs.
    3. Regulation: – ETD contracts are heavily regulated by the market regulators and exchanges are not permitted to allow trades unless proper processes for margin payments, clearing and settlement are laid out.OTC contracts are loosely regulated. ISDA (International Swaps and Derivative Association) master agreement is the most commonly used master service agreement.
    4. Counterparty Risk: – Exchange\Clearing house acts as a guarantor to all trades taking place over the exchange. Exchange requires the participants deposit margin based on the participants risk profile and the contracts that they have traded on. These margins are used to reimburse the counter-parties in the event of a default. As such there is very little counterparty risk. OTC contracts, however, requires the participants to be aware of each other’s credit quality since there is no clearing house guarantee. Of late there have been some changes in the regulations whereby OTC contracts are required to be processed via clearing house.
    5. Products: – Futures and Options are the most commonly traded derivative products on exchange while swaps, forward rate agreements, exotic options etc. are some of the most widely traded OTC derivative instruments.

    Posted under: Finance
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    One Comment

    1. minaxi says:

      Hi,
      What is the difference between OTC and ETD while booking as we are using RMS trade entry tool for booking Forex Trade.

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