Derivatives are tradable contracts.
Properties of Derivatives
Where is it traded?
- Over-the-Counter (OTC): the two parties arrage the terms by themselves. Harder to price.
- Exchange-traded: everybody goes to the central exchange to trade. Higher liquidity.
Do you need to execute?
- Non-contingent: No need to execute. Options (Finance)
- Contingent: Must execute. Futures, Forwards, Swaps, etc.
Margin
Margin fully mitigates couterparty risk. Clearinghouse requires both parties to post initial and variational margin as the underlyer fluctuates in value.
- Initial Margin: the margin you pay
- Variational Margin: you add onto margin every time