Lesson 4 of 5 · 14 min
OTC and exchange-traded derivative markets
OTC derivatives are private, customized contracts with a dealer, while exchange-traded derivatives are standardized, transparent and backed by collateral and an exchange guarantee.
In short
- OTC markets are networks of end users and dealers (financial intermediaries, also called market makers); dealers lay off risk through offsetting transactions with one another.
- OTC terms can be customized to match a specific exposure; the trade-off is less transparency, more counterparty risk and often less liquidity.
- Exchange-traded derivatives (ETDs), mainly futures and options, have standardized terms set by the exchange (size, underlying quality and location, maturity), which supports liquidity and transparency.
- Exchange market makers earn a bid-offer spread; speculators take on risk when dealers cannot find a counterparty.
- Clearing verifies and records the trade and payments; settlement is the final payment or delivery. Exchanges require collateral and guarantee against counterparty default.
Unlock this lesson free for 7 days
Create a free account to get 7 days of full access — every lesson, video, flashcard, mock and the question bank. No card needed.