Exchange Traded Derivatives
Unlike the OTC instruments, these are traded over an exchange. So in these contracts Exchange play an intermediately to all transactions.
- There is a third party in ETD and that is Exchange.
The exchange provides a platform, where the buyers and sellers can come together and the orders are matched. Once this orders are matched, the exchange becomes seller to the buyer and buyer to the seller.
- Exchange saves one party from the counterparty risk and default of another party.
To do that the exchange charges a margin money, from both sides as collateral. The margin money varies depending upon the day to day price movements.
- ETDs can be used for both speculation and hedging.
The Exchange Traded Derivatives are of two types viz. Futures and Options.
- Futures: Futures is a contract between two parties, in which one party agrees to buy an underlying asset from the seller at a future date at a price which is agreed upon today.
- The terms of the agreement are decided by the exchange and not the parties.
- The prices are NOT decided by the exchange.
- Both buyers and sellers are protected by a margin money which is equal to the loss of one party in the futures.
- In India the clearing corporations such as NSSCL (National Securities Clearing Corporation Limited) protects the parties against the counterparty risk.
- Options: Option is a contract between two parties, in which one party has an option to buy an underlying asset from the seller at a future date at a price which is agreed upon today. One party gives another party the Option or right but NOT the obligation.
- In India, the trading in options in interest rate derivatives is NOT allowed as of now.