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.

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