BAJAJ BROKING
Derivatives are becoming an increasingly popular tool to manage risk. Multiple derivative instruments help traders hedge against sudden price fluctuations or take advantage of market volatility. Futures and forwards are among the most popular derivative instruments used by traders. This article aims to elaborate on the difference between forward and future contracts.
Derivatives typically have an underlying asset associated with them. Derivative trading is carried out based on the price fluctuations of the asset, which could be in the form of stocks, commodities, bonds etc. We can trade Derivatives in two ways: (i) when the stock exchange acts as a counterparty, derivatives are traded as standardised financial contracts. These are also known as exchange-traded derivatives, (ii) over-the-counter derivatives, i.e., without the intervention of a formal intermediary.
A futures contract is an agreement between two entities to conduct a transaction at a locked-in price at a predetermined date in the future. The futures contract buyer is not required to pay the entire amount upfront. Instead, only a small initial outlay must be paid, which makes futures trading highly leveraged. The standard terms and conditions of a futures contract are:
Let us understand how futures contracts work with some examples.
A forward contract is a privately negotiated agreement between two entities that comprises buying or selling an underlying asset at a pre-set date and an agreed-upon price. Such contracts can be traded in different over-the-counter derivatives such as commodities, stocks etc.
Features | Forward Contract | Future Contract |
Regulation | Self-regulated. | Regulated by the Securities and Exchange Board of India (SEBI). |
Collateral | Forward contracts do not require an initial margin. | Futures contracts require a specific margin following the regulations of the exchange. |
Maturity | Forward contracts may be set to mature on the date as decided upon in terms of the private contract. | Futures contracts mature on a predetermined date. |
Settlement | The parties entering the contract may negotiate the settlement terms. Settlement of Forward contracts happens upon maturity. | The exchange settles futures contracts daily. |
Here are some of the other significant features of forward contract vs future contract.
Forward and future contracts can provide excellent means to manage strategies and hedge against price fluctuations. The difference between futures and forwards is that futures provide standardised contracts, whereas forwards are based on customisable contracts involving two parties. However, since the exchange regulates futures, they are not exposed to risks such as default or counterparty risk.
Share this article:
Level up your stock market experience: Download the Bajaj Broking App for effortless investing and trading