Let us learn about the exchange traded derivatives and over the counter (OTC) before understanding the differences between them.
With a standardized contract, exchanged traded derivatives consist of options and futures mostly and traded on public exchanges. Determines expiry date, settlement process, lot size and states underlying instruments on which derivatives are created. By providing market based pricing information these derivatives promote transparency and liquidity.
Clearing and settlement
Clearing houses will handle both clear and settlement required tasks. Initial deposit required for a clearinghouse.
These securities are traded between parties without supervision of the exchange regulator. These are done through dealer networks in over the counter markets.
OTC securities cover a wide range of financial instruments (stock, derivatives, and debt securities) and commodities. Mostly covers stocks of smaller companies and sometimes cover stocks of larger companies.
Over the counter derivatives have exceptional significance and provide greater flexibility so that investors can adjust derivative contracts to suit their risk exposure. Trading OTC increases the liquidity in markets. Significant risk in OTC trading is counterparty risk. Fair value determination is based on contract design, more complicated the design and determination of fair value becomes harder.
The major differences between exchange traded derivatives and over the counter (OTC) are as follows −
|Sr.No||Exchanged traded derivatives||Over the counter (OTC)|
|1||Traded on exchange.||Traded on phones or through computers.|
|2||Contract is standardized.||Contract terms are agreed between the buyer and seller.|
|3||Information is public.||Information is private.|
|4||Termination is easy.||Difficult to terminate early.|
|5||Has a third party guarantor (clearing house).||No third party guarantor.|
|6||Require performance bond.||Performance bonds are not required.|