What is the Differences Between Forward and Futures Contracts

The difference between the forward and futures contracts basically exists in the nature of the contract and the way they are processed and supervised. In a forward contract, the contract is privately negotiated between the traders, and the conditions are tailored to suit individual traders, while in a futures contract, the contract is standardised, and it is traded on recognised exchanges. Both contracts enable traders to set up a future market price, but the flexibility and risk associated with the contract differ. Understanding the difference between two contracts is essential for traders and organisations to select the correct option according to their risk tolerance. This article explains the forward contract vs future contract. 

Difference Between Futures Contracts and Forward Contracts 

The following table highlights the difference between forward and future contract. 

Similarities Between Futures vs Forwards Contracts 

After understanding the future and forward contract difference, let’s also look at how they are similar. Although the two derivatives differ in many ways, they have some common aspects too. The following are some similarities between forwards vs futures contracts.  

1. Both agreements are derivative contracts. 
2. A future purchase or sale of derivatives is involved. 
3. These agreements aid in reducing risk and losses resulting from fluctuating prices.  
4. Both contracts rely on strategies to fix the cost. 
5. The buyer and seller must complete the transaction on a certain date according to both of these contracts. 

Features of Forward and Futures Contracts 

Let's understand the features of forward and futures contracts 

Features of Futures Contracts 

• Standardised and Exchange-Traded Structure :Futures contracts follow uniform terms set by the exchange, ensuring consistency, transparency, and easy participation for investors. 
• Margin System and Leverage: Traders must maintain initial and maintenance margins, which also allow them to take larger positions with relatively lower capital. 
• Daily Settlement and Risk Control : Futures contracts are Mark-to-market (MTM) daily, helping manage losses in real time and reducing counterparty risk. 
• Liquidity and Price Transparency: Since futures are actively traded on exchanges, real-time pricing allows investors to enter or exit the position easily. 
• Wide Asset Coverage and Fixed Expiry: Futures are available across commodities, indices, and financial instruments, each with a predefined expiration date. 

Features of Forward Contracts 

•  Customised and Over-The-Counter (OTC) Based Agreements: Forward contracts are privately negotiated, allowing parties to decide asset type, quantity, price, and delivery date. 
• Flexible Settlement Options: Settlement can occur through physical delivery or cash settlement, based on mutual agreement. 
• No Margin Requirement: Since forwards are unregulated, no margin is required, making them suitable for specific hedging needs. 
• Commonly used for corporate hedging: Businesses use forward contracts to manage price or interest rate risk linked to future obligations. 

Which Is Better: Forward or Future? 

Whether a forward or future contract is suitable depends on the purpose, risk tolerance, and level of flexibility an individual or business requires.

1. Forward contracts may be suitable for an exporter, farmer, or other businessperson who wants customised hedging with no margin obligations. 
2. Traders or investors looking to speculate on market prices or hedge their investment portfolio can consider futures contracts because they are more liquid, well-regulated, and offer risk control. 

Disclaimer: All investments are subject to market risks, economic conditions, regulatory changes, and other external factors. Returns are not guaranteed and may vary based on market performance and investment tenure. Investors should assess their risk tolerance and financial objectives, conduct their own research, and consult a qualified financial advisor before making any investment decisions. 

Conclusion 

Forward and futures contracts both assist in managing uncertainty of future prices, but they serve different purposes based on flexibility, regulation, and risk levels. In forward contracts, there is flexibility but also a high default risk; on the other hand, futures contracts provide transparency, liquidity, and regulatory protection. Investors can trade and manage these contracts efficiently with the help of a reliable online trading app.