Derivatives Trading, Clearing and Settlement
Core concepts
Trading occurs on exchanges (order-driven, transparent) and OTC (quote-driven, bilateral). Know order types: market, limit, stop, stop-limit, and time-in-force instructions (day, GTC, IOC, FOK). Understand the trade lifecycle: execution, confirmation, clearing, settlement. Clearing novates the trade to a CCP, which becomes buyer to every seller and seller to every buyer; settlement transfers cash and/or securities.
Learn netting (bilateral and multilateral), novation, and the role of clearing members and clients. Know the difference between payment versus payment (PvP) and delivery versus payment (DvP), and the T+1/T+2 settlement cycle concept. Understand straight-through processing and trade reporting obligations.
Traps
Questions often confuse clearing with settlement: clearing manages counterparty risk and obligations; settlement is the actual exchange of value. Another trap is order-type direction: a stop-buy triggers above the market, a stop-sell below. Limit buys execute at or below the limit; limit sells at or above. Watch for 'market order guarantees price' - it guarantees execution, not price.
Worked example
A trader places a limit buy at 100 when the market is 102. The order rests until the price falls to 100 or better; it will not fill at 102. If a stop-sell is placed at 95 with the market at 100, it triggers only when the market trades at or below 95, then becomes a market order.
Rule of thumb
Execution → clearing (CCP novation, netting) → settlement (exchange of value). Each stage has distinct risk controls and reporting duties.