What is the Difference Between Forward and Futures Contract

 

If you want to become a master of stock trading, you must be aware of potential terms and tactics that may help you in the future. Equity, commodity are the important segments of a stock market. Apart from these segments, there is also a much broader segment which has helped many investors to gain potential returns.

  One such important element is derivative trading. Derivative trading is something that helps traders to achieve any financial goals. Even stock market giant Warren Buffet once said, the total money involved in derivative trading is much greater than actual money available in the market.

 Basically, derivative trading is managed on the basis of price movement of a derivative product’s underlying asset. The assets could be anything: equities, commodities, stocks, currencies, bonds and so on.

 

What is a Futures Contract ?

 A Futures contract is a standardized financial contract that is traded through brokerage firms which traded at a specific contract. Futures contract is a legally binding agreement between buyer and seller where buyer and sellers both agree to perform transactions of financial assets at a later date.

 A Futures contract is based on the following parameters:

 Quantity: Here quantity is the unit amount of underlying assets.

Price: Futures are prices decided by the open market and buyers/sellers trade their securities on the fixed price.

Settlement Procedure: Each futures contract is settled financially at expiry.

Expiration Date: An expiration date is the date the contract is no longer available.

 

Currency Futures is one of the finest examples of Futures contract. It is also known as FX Futures. Using this contract, traders can exchange one currency with another on a given date in future. In India, you can use Futures contracts on four pairs of currencies: Indian Rupee and US Dollar, Indian Rupee and United Kingdom Pound, Indian Rupee and Euro, Indian Rupee and Japanese Yen.

 

What is a Forward Contract ?

A Forward contract, also known as forwards is a private agreement between two parties to buy and sell the underlying asset at a predetermined price and fixed price. Forward contracts are customizable derivative products. These contracts come under private agreements and are traded in over-the-counter (OTC) capacity. Like Futures contract, Forward Contract is also based on the following parameters:

 

Quantity: In Forward Contract, participants agree to a predetermined asset quantity.

Price: Buyers and sellers agree to an up-front contract price.

Expiration Date: Forward contracts also have an expiry date.

Settlement Procedure: Whether you are a buyer or seller, contracts are settled financially.

Futures Vs Forwards Contracts:

Though these financial instruments seem to be very similar, they possess slight difference:

Here are a few differences:

Exchange vs OTC:

Futures are standardized exchange traded products and therefore they are easily available to the public. Forwards are non-standardized OTC issues, and hence they are privately traded.

Market Price Vs Set Price:

Futures contracts heavily depend on the process of price recovery. As a result, a contract’s price may fluctuate from launch to expiry. This isn't the case with forwards. Although price is relative to the underlying asset, forward contracts mainly work on fixed price.

Counterparty Risk:

Futures are not subjected to counterparty risk because all transactions cleared through a formal exchange. If a buyer or seller fails to meet the obligations, the contract may become devalued or worthless.

Getting Started with Futures and Forward:

Futures and Forwards offer participants a wide range of ways to get into such contracts.

Takeaway:

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