ETDs, short for Exchange-traded derivatives, are financial instruments between two or more parties, gaining or losing value depending on the agreed-upon asset price changes. These agreements can be set around various financial assets, including forex, stocks, treasuries and bonds. These instruments can be obtained on exchange platforms and are regulated by relevant market authorities. These excellent financial mechanisms offer numerous advantages, including elevated liquidity, air-tight regulation and mitigated risks.
Advantages And Unique Benefits
ETDs are exceptional choices for investors who wish to trade with derivative mechanisms. They allow investors to raise liquidity conveniently and without compromising their regulatory integrity. Let’s explore some of the most prominent benefits:
Standardised Across The Board
The rules and regulations of the respective exchange authority standardise every ETD agreement. While these contracts might differ in various jurisdictions, the local market players can reliably predict the terms and conditions of the agreement. Predictability is very important as it allows traders to construct long-term trading strategies.
These trading mechanisms are exceptionally liquid, boasting impressive market depth. The high liquidity aspect allows traders to swiftly match orders and partner with counterparties without sacrificing their desired prices.
The ETD market is strictly regulated by relevant authorities that oversee the trading market activities in different countries. For example, the Securities and Exchange Board audits and monitors the market in the USA. The high degree of regulations makes these contracts safe for trading, as respective regulatory bodies closely monitor them.
Enhanced Agreement Protection
ETD contracts are designed with intermediaries in mind, managing and executing the agreement for both sides without bias. Thus, ETDs feature few to no counterparty risk and default possibilities, as the intermediaries fulfil contractual obligations without delays.
Different Variations And Types
As they are applicable to a wide variety of commodities in the trading industry, ETDs exhibit a multitude of variations on the market. Let’s go through a few examples of the most common kinds. Stock ETDs are one of the most popular instruments on the market and feature different types of contracts, including stock options and forwards. Stock contracts allow investors to acquire highly leveraged positions on the stock price movements in both short and long-term periods. On the other hand, Index ETDs let traders acquire or sell an entire stock portfolio instead of dealing with specific stock options.
With currency derivatives of this kind, traders can take long or short positions on any currency pairs they choose. The same applies to commodity derivatives, where investors can bet on the price movements of real-world assets like gold.
Despite their shady reputation after the 2008 economic crisis, numerous investors still view real estate ETDs as an excellent investment to diversify portfolio risks.
ETDs Compared to OTCs
OTC derivatives are quite similar to ETDs. Both contracts are focused on the future date, giving investors the opportunity to set purchase prices in the current period. However, OTC agreements are not mediated by a third-party entity. Instead, they are managed privately between the two counterparties. Thus, OTCs offer more customisation and freedom for involved parties but come with certain trade-offs.
Personalisation Vs Reliability
As discussed above, ETDs have a much higher standardisation level than OTCs, which is excellent for elevated liquidity and value normalisation. Conversely, OTCs offer much more flexibility and freedom, letting counterparties determine their terms and conditions. However, the high level of customisation negatively affects the availability of these instruments, as it is much harder to find matching counterparties with custom conditions. Thus, these mechanisms are often more expensive and rare compared to ETDs.
Additionally, ETDs minimise the default risks by involving intermediaries. These third-party regulators ensure that both sides honour an agreement without delays or any alternative actions. On the other hand, OTCs do not have this luxury, as they have to be settled exclusively by the two involved parties. Naturally, the absence of moderators creates trust risk with the OTCs, as there are no safeguards to prevent this possibility.
ETDs, although being standardised and having little customisation possibilities, are great trading instruments for professionals. They provide high liquidity and stability and are secure from default or counterparty risks.