Based on the markets where they are created and traded, derivatives can be classified into two groups.

Exchange-Traded Derivatives Markets

Exchange-traded derivatives are created, authorized, and traded on a derivatives exchange, an organized facility for trading derivatives.

• They are standardized instruments with respect to certain terms and conditions of contracts. This specification applies to features like the schedule of expiry dates and contract magnitude. The market participants in the exchange-traded derivatives markets are the market-makers (dealers) and speculators who are typically exchange members. The interplay between market makers and speculators creates a more liquid and more orderly market.

• The standardization also ensures clearing (verification of transaction and identities) and settlement (transfer of money) of derivatives contracts happens efficiently and allows for the provision of a credit guarantee by the clearinghouse. The clearinghouse can provide this guarantee through the requirement of a cash deposit called a margin bond or performance bond.

• Exchange-traded markets have transparency as full information on the transactions is disclosed to the exchange and regulatory bodies. This does mean a loss of privacy and, coupled with the standardization, a loss of flexibility. As an alternative to standardization, OTC markets provide a substitute for firms wishing to trade non-standardized products.

Over-the-Counter Derivatives Markets

Over-the-counter derivatives are transactions created by any two parties off a derivatives exchange.

• They don't have standardized terms and features. The parties set all of their own terms and conditions, and each party assumes the credit risk of the other party. It can be difficult for a dealer to find a contract that is a perfect match to hedge a position, and they usually have to rely on similar transactions in which they can lay off their risk. The ability to customize OTC contracts does not necessarily make the market less liquid than the standardized exchange-traded contracts. As many of the OTC instruments can be easily created, an offsetting instrument can be created, oftentimes between the same two transacting parties, to terminate the position.

• OTC markets do have a lower level of regulation than exchange-traded markets. However, post the 2007 financial crisis, regulatory oversight has been increasing. On full implementation of new rules, many OTC transactions will have to be cleared through central clearing agencies with information reported to the regulatory authorities.