Exchange Traded Products are standardized financial instruments you can trade on an organized exchange. Over The Counter or derivative products are financial instruments traded away from exchanges.
Prices rest on values of one or more underlying commodities, equity indices, securities, debt instruments, or agreed upon arrangements or pricing indices.
The biggest difference, and crucial distinction, is the distinction of customization versus standardization. ETD product terms have a set standard. A clearing house gives you a guarantee the other side transaction meets their obligations in any transaction.
The clearinghouse takes on all contingent default risks, meaning neither side need not worry about the other’s credit status. In OTC trading transactions, such a guarantee does not exist.
Two notable types of markets where derivatives are traded are:
- Exchange-Traded Derivatives
- Over the Counter (OTC) Derivatives
ETDs are traded via a central exchange where the prices are visible to the public.
On the other hand, trading OTCs derivatives involves two parties (bilateral negotiation) and doesn’t involve exchanges or other third parties. OTC stocks are traded through a dealer network instead of a centralized exchange. These stocks are called “unlisted” where the securities are traded through direct bilateral negotiation.
ETDs and OTCs are two different types of markets that reinforce each other and fulfil different clients’ needs. For example, ETDs involve better price transparency as opposed to OTCs. Additionally, exchange-traded derivatives involve lower counterparty risks as all of the trades are being settled on a daily basis with the clearinghouse.
On the other side, over the counter markets are more flexible and might be a better choice for investors that place trades that don’t involve high order flow or specific demands.
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