Futures and forwards are financial derivatives that are used to hedge against or speculate on the price movements of an underlying asset. The forwards gave birth to derivative markets and were initially used for various commodities only. With the development of the financial markets and technologies that improve the ease of transactions, equities, bonds, commodities, or various baskets of instruments became available as underlying assets. Futures similar in that they both allow two parties to enter into an agreement to buy or sell an asset at a specified price on a future date, however there are some key differences between futures and forwards:

• Exchange traded: Futures contracts are traded on a futures exchange, while forwards are traded over the counter (OTC). The futures exchange contracts are typically more standardised and liquid, while OTC contracts can be customised and traded directly (though there is usually a third party that is present in order to limit the credit risks of a transaction.
• Margin requirements: Futures traders are required to post margin, or collateral, to cover potential losses on their positions, while forwards do not necessarily require a collateral.
• Settlement: Futures contracts are settled in cash, which is especially important to understand when trading commodities. The forwards can be settled in cash or by delivering the underlying asset.

Both futures and forwards can be used for hedging or speculative purposes. Their differences though allow them to better suit different types of investors under varying market conditions. For example, futures are often used by commercial hedgers to lock in the price of a commodity that they plan to buy or sell in the future, while forwards are more commonly used by investors to speculate on the direction of an asset’s price.

Please note, none of the information on this blog represents the opinion of my employer and all information does not represent a financial advice.