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 (known as the OTC market ).
A forward (forward contract) is a bilateral contract that obligates one party to buy and and the other party to sell a specific quantity of an asset, at a specified 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 are carried out in a secondary market, are regulated, backed by the clearing house, and require daily 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:
- Settlement: Futures and forward contracts can be deliverable settlement 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 time an investor enters 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 forward currency forward contracts, which are more liquid than currency futures.
- Standardization: Futures, on the other hand, are standardized contracts in contract sizes and in terms of terms and conditions. For their part, the terms and conditions of the forwards (for example, collateral size, contract size, 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 into bankruptcy or default and 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. Generally, forward contracts are not mark-to-market.
- Regulation: The government regulates the futures markets. Forward contracts are normally unregulated.
The party in the futures contract that agrees 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 / ship 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.