Difference Between Forward and Future

Although financial futures and forwards have many similarities, they also have several differences. The main one is that futures are traded on regulated markets and forwards are traded directly between the parties (what is known as the OTC market ).

A forward (forward contract) is a bilateral contract that obliges one party to buy and the other party to sell a specific quantity of an asset, at a certain price, on a specific date in the future.

A futures contract is a forward contract that is standardized and traded on an organized market.

The main differences between forwards and futures are that futures transactions and negotiations take place in a secondary market, are regulated, backed by the clearing house, and require daily settlement of profits and losses (mark-to-market). . All futures transactions are regulated by the Commodity Futures Trading Commission (CFTC).

Difference between forward and future

Futures contracts are similar to forward contracts in the following points:

  • Settlement: Futures and forward contracts can be either deliverable (ie, the underlying asset must be delivered) or cash settlement contracts.
  • Initial prices: The price of futures and forwards has zero value at the moment an investor enters the contract.

Futures contracts differ from forward contracts in the following ways:

  • Organized market: Futures contracts are traded in organized markets and provide daily liquidity (ability to undo the high position). The exception is confirmed in currency forward contracts, which are more liquid than currency futures.
  • Standardization: Futures, on the other hand, are standardized contracts in terms of contract sizes and terms and conditions. On the other hand, the terms and conditions of the forwards (for example, size of guarantee -collateral-, size of the contract, delivery conditions...) are adapted to the needs of the parties involved.
  • Clearinghouse: A single clearinghouse is the counterparty to all futures contracts. The chamber commits the members by forcing them to deposit a capital and a guarantee. Forwards are bilateral contracts with their own counterparty, so they contain a significantly higher risk of being able to go bankrupt or default and not comply with what is established in the contract.
  • Mark-to-market: Futures contracts have a daily mark-to-market, this means that the price of the contract is reviewed every day and each of the parties deposits the guarantee or not. Forward contracts are generally not mark-to-market.
  • Regulation: The government regulates futures markets. Forward contracts are normally not regulated.

The party to the futures contract who agrees to buy/receive the financial or physical asset has a long futures position and is known as being "long". The party to the futures contract that agrees to sell/deliver the asset has a short futures position and is known as being "short". A long position and a short position in the same futures contract are counted as a single contract towards open interest or risk. Only about 1% of all futures contract positions involve delivery of the underlying commodity.