Clearing is a fundamental benefit in the futures markets. Long before a trade is cleared through a clearing house, clearing firms check the financial strength of both parties to the trade, whether they’re a big institution or an individual trader. They also provide access to trading platforms, where the buyer and seller agree on the price, quantity and maturity of the contract. Then, when the contract is cleared by matching these offsetting (one buy, one sell) positions together, the clearing house guarantees that both buyer and seller get paid. This offsetting or “netting” process takes risk out of the financial system as a whole.
How clearing works
Clearing houses provide clearing and settlement services for futures traded at an exchange. They act as the neutral counterparty between every buyer and seller, ensuring the soundness and integrity of every trade.
Clearing made clear
This is more or less what you see when you make an electronic trade. Behind the scenes, however, a number of things happen to make sure that the trade goes through without a hitch.
Bob's order is sent to the clearing house
If Bob is good to go, the clearing firm then submits his order to the central clearing house at the exchange. This clearing house is a major part of any exchange because all orders flow through it, and all clearing firms must meet very specific criteria to work with it.
The nitty-gritty details get worked out
At this point, the clearing house is legally responsible for all the risk related to the trade. Its job is to make sure that Bob and the cattle rancher agree on the price, quantity and timing of their futures contracts. If at any point there’s a glitch, the trade is stopped.