The financial futures and forwards are both financial derivative term according the delivery of a physical commodity or a financial asset in the future at a previously set price and date. Despite having many similarities they have several differences. The main one is that futures are traded on regulated markets and forward are traded directly between the parties (what is known as the OTC market ).
A forward (forward contract) is a bilateral contract that requires one of the parties to buy and the other party to sell a specific amount of an asset, at a specific price, on a specific date in the future.
A futures contract is a forward contract that is standardized and negotiated in an organized market.
The main differences between forward and futures are that futures transactions and negotiations are carried out in a secondary market , are regulated, backed by the clearing house , and require daily profit and loss (mark-to-market) settlement. . 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:
- Liquidation: Futures and forward contracts can be deliverable liquidation contracts (for example, the underlying asset must be delivered ) or in cash.
- Initial prices: The price of futures and forwards has zero value at the moment in which an investor enters into the contract.
Futures contracts differ from forward contracts in the following ways:
- Organized market: futures contracts are traded on organized markets and provide daily liquidity (ability to undo the high position). The exception is confirmed in forwards forward contracts on currencies, which are more liquid than currency futures contracts.
- Standardization: futures for their part, are contracts standardized in contract sizes and in terms of terms and conditions. On the other hand, the terms and conditions of the forwards (for example, guarantee size – collateral-, contract size, delivery conditions …) are adapted to the needs of the parties involved.
- Clearinghouse: a single clearinghouse is the counterpart of all futures contracts. The chamber commits the members forcing to deposit a capital and a guarantee. Forwards are bilateral contracts with their own counterparty, so they contain a significantly higher risk than being able to go bankrupt or default and do not comply with the provisions of the contract.
- Mark-to-market: Futures contracts have a daily mark-to-market, this means that the price of the contract is reviewed day by day and each of the parties deposits or not the guarantee. In general, forward contracts are not mark-to-market.
- Regulation: the government regulates futures markets. Forward contracts are usually not regulated.
The part in the futures contract that commits to buy / receive the financial or physical asset has a long futures position and is known as being “long”. The party in the futures contract that agrees to sell / send 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 interest or open risk. Only about 1% of all futures contracts involve the delivery of the underlying commodity.