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Over-the-Counter vs. Over-the-Exchange

It’s hard to talk about futures without mentioning options over-the-counter contracts, particularly those in the interest rate, foreign exchange and commodities markets. Over-the-counter, or OTC, trades are those that take place between a buyer and a seller outside of a formal exchange.

OTC derivatives let traders go beyond standardized futures products and customize the terms of the contracts they trade. Usually, the traders work through a network of dealers who negotiate these agreements on a one-to-one basis. Though it offers greater freedom and potentially lower trading costs, OTC trading may leave both parties at risk for counterparty default if they are not using the services of a clearing house.