I’ve recently taken quite an interest in the financial sector, the Derivatives Market in particular. On average there are more than 500 exchange-traded derivative contracts are completed every 5 seconds. These derivatives are not discussed as often as Over-The-Counter trades such as Swap Rates or Credit Default Swaps. However with the newest financial regulations implemented, the exchange-traded derivatives or futures trades have become a more viable option for businesses operational strengths. But what are exchange-traded derivatives?
Exchange-traded derivatives are products that are listed for public trading and are organised on a futures exchange compared to OTC derivatives such as an Interest Rate Swap that is traded privately. They require a payment of the initial deposit, which is then settled through a clearing house. The exchange acts as a middleman to transactions and guarantees payment through an initial margin from both sides of the train. Therefore, there is reduced counterparty risk relative to OTC derivatives. The top derivatives exchanges include the Korea Exchange, Eurex and CME group.
These contracts can include:
- Call option (“call”): A financial contract between 2 parties, the buyer and the seller. The buyer of the call has the right (but not the obligation) to buy an agreed upon commodity or financial instrument from the seller at a certain time (expiration date). The seller is obliged to sell the commodity/financial instrument if the buyer decides but the buyer pays a fee for this right.
- Put option (“put”): This is a stock market tool that gives the owner the right, but no the obligation, to sell an asset at a specified price by a date (expiry or maturity date) to a given buyer. They are commonly used in the stock market to protect against a decline of the price of a stock below a certain threshold.
- Futures Contracts (“futures”): A standardized contract between two parties to sell or buy a specific asset of standardized quality and quantity for a price agreed upon and the delivery and payment occur on a specific future date (delivery date).
The exchange-traded options offer standardized contracts, immediate access to the price and the use of clearing houses by exchanges. The clearing houses will guarantee that the option contract is fulfilled and transparency although this is also becoming the norm for over-the-counter trades.