OTC vs Exchange-Traded Derivatives
Derivatives trade either on an organised exchange (standardised, cleared, margined, transparent) or over-the-counter (customised, bilateral, privately negotiate...
Two Market Structures
Derivatives trade either on an organised exchange (standardised, cleared, margined, transparent) or over-the-counter (customised, bilateral, privately negotiated). The structural differences drive the credit risk, cost and accessibility of each market.
On an exchange (NSE, BSE, MSEI in India), contracts are standardised — fixed lot size, fixed expiry, fixed tick size. A central clearing corporation becomes the counterparty to every trade through novation, so credit risk is mutualised through margin and the Settlement Guarantee Fund. OTC markets (primarily used by banks, corporates, FIs and HNIs) negotiate every clause — size, tenor, underlying, settlement — giving maximum flexibility at the cost of bilateral credit risk and thin liquidity. Post-2008, global regulators have pushed standardised OTC contracts through central counterparties (CCPs) to reduce systemic risk.
Exchange = off-the-shelf SKUs; OTC = custom stitched to size
On the exchange the CC guarantees every trade — you never know who the actual counterparty is
OTC deals hide in bilateral ISDA agreements — regulators can't easily see the book
Exchange-traded = automatic daily MTM and margin calls; OTC = annual contract review at best
A Practical Example
| Feature | Exchange-Traded | OTC |
|---|---|---|
| Contract terms | Standardised | Customised |
| Counterparty | Clearing Corporation (CC) | The bilateral counterparty |
| Credit risk | Mutualised via margin + SGF | Direct bilateral |
| Regulation | Heavy (SEBI / exchange rules) | Light (ISDA master agreements) |
| Margining | Daily MTM + initial + exposure margin | Bilateral collateral if any |
| Settlement | Via clearing corp, T+1 | Bilateral as agreed |
| Typical users | Retail + institutions | Banks, FIs, corporates, HNIs |
What Makes This Important
Frequently Asked Questions
OTC lets them match exact notional amounts and exact settlement dates to real cash flows (e.g., $50M on day 273). Exchange contracts force standard sizes and dates, requiring over- or under-hedging.
🧠 Quick Quiz
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