Futures and Options Serving Intelligent Investors
Futures contracts vs. Forward contracts
A futures contract, often referred to as futures, is a standardized version of a forward contract that is publicly traded on a futures exchange (CME, LME etc.). Like a forward contract, a futures contract includes an agreed upon price and time in the future to buy or sell an asset, usually stocks, bonds, or commodities, like gold, crude oil, AAPL.
A forward contract is a customized contractual agreement where two private parties agree to trade a particular asset with each other at an agreed specific price and time in the future. Forward contracts are traded privately over-the-counter, not on an exchange.
Comparison chart
Forward Contract |
Futures Contract |
|
|---|---|---|
| Definition | A forward contract is an agreement between two parties to buy or sell an asset (which can be of any kind) at a pre-agreed future point in time at a specified price. | A futures contract is a standardized contract, traded on a futures exchange, to buy or sell a certain underlying instrument at a certain date in the future, at a specified price. |
| Structure & Purpose | Customized to customer needs. Usually no initial payment required. Usually used for hedging. | Standardized. Initial margin payment required. Usually used for speculation. |
| Transaction method | Negotiated directly by the buyer and seller | Quoted and traded on the Exchange |
| Market regulation | Not regulated | Government regulated market (the Commodity Futures Trading Commission or CFTC is the governing body) |
| Institutional guarantee | The contracting parties | Clearing House |
| Risk | High counterparty risk | Low counterparty risk |
| Guarantees | No guarantee of settlement until the date of maturity only the forward price, based on the spot price of the underlying asset is paid | Both parties must deposit an initial guarantee (margin). The value of the operation is marked to market rates with daily settlement of profits and losses. |
| Contract Maturity | Forward contracts generally mature by delivering the commodity. | Future contracts may not necessarily mature by delivery of commodity. |
| Expiry date | Depending on the transaction | Standardized |
| Method of pre-termination | Opposite contract with same or different counterparty. Counterparty risk remains while terminating with different counterparty. | Opposite contract on the exchange. |
| Contract size | Depending on the transaction and the requirements of the contracting parties. | Standardized |
| Market | Primary & Secondary | Primary |
