March 8, 2021

What are Forward Contracts?

Forward contracts are one of the different types of derivatives that traders can have access to. It is possible to get exposure to a specific asset using forward contracts. Nevertheless, the term is often confused with Futures contracts. These are two different terms that are used to describe two different types of contracts.

Forward contracts are one of the different types of derivatives that traders can have access to. It is possible to get exposure to a specific asset using forward contracts. Nevertheless, the term is often confused with Futures contracts. These are two different terms that are used to describe two different types of contracts. 

This guide will share with you the main differences between forward vs futures contracts. At the same time, you would learn how to buy futures contracts and more. 

Disclaimer: the information shared in this post should not be considered investment advice. We are not financial advisors. The content should be considered for educational purposes only. Never invest more than what you are able to lose. 

What are Forward Contracts?

Forward contracts are customized contracts that involve the trade of an asset for a predetermined price at a specified date. Forward contracts are usually handled over-the-counter (OTC) and include the participation of two different parties. 

These two parties negotiate the terms they need in order to sign the agreement. Some of the things that are discussed through these deals include the expiration date of the contract, the number of contracts that will be transacted and the definition of the asset that is going to be traded. 

Forward contracts can be traded for specific periods of time (for example quarterly). But they can also involve different price settlements. The maturity of the contract would depend on the arrangement made between the two parties involved in the trade. 

As you can see, there is a clear characteristic of forward contracts: they are customizable. This is something that we cannot do with futures contracts. 

What are Futures Contracts?

Futures contracts make reference to agreements between two parties to trade a contract for a specified price and at a predetermined date in the future. Rather than negotiating the terms of the settlement, the details are predetermined and cannot be changed. Thus, these are more standardized contracts. 

Futures contracts can be agreed on different assets, including forex futures contracts, digital assets such as Bitcoin (BTC), commodities and more.

How to Buy Futures Contracts?

Futures contracts can be purchased in most of the trading platforms currently available in the market. You can open an account on a trading platform available in your region and start trading futures contracts. 

Futures exchanges are the most popular platforms to handle these types of contracts. However, some traditional exchanges have also added a section to trade futures. This is making them available to a larger number of investors from all over the world. 

Forward vs Futures Contracts

The main difference between forward vs futures contracts is the standardization and customization of the contract. While forward contracts can be customized and arranged between two parties, futures contracts have standardized terms that apply to everyone. 

Furthermore, due to the customization of these contracts (forward contracts) they have to be traded in OTC desks. They cannot be added to an exchange platform because the details must be arranged between two different parties. 

Instead, futures contracts can be easily traded in different exchanges and trading platforms. In the cryptocurrency market, for example, Binance, BitMex or ByBit are already offering clients the possibility to trade futures contracts. 

Both futures and forward contracts are derivatives that follow and track the price of an underlying asset. For example, they represent the price of a cryptocurrency, a commodity, or stocks, among other things. Indeed, there are also forex forward contracts that can be purchased and traded. 

Forward and futures contracts can both be used to hedge against future price changes. At the same time, these contracts can also be used to speculate on the price of an asset. 

Forward Contracts Example

This is the example of a forward contract:

If you want to buy a December crude oil forward contract, you would go to an OTC desk that is currently offering forwards contracts trading. The OTC desk would contact the other party that would sign the forward contract. 

The seller would agree to sell a determined number of barrels (contracts) at an agreed price. Compared to a futures contract, these terms are going to be arranged through the OTC desk. You would not be able to find forward contracts on traditional exchanges and trading platforms. 

Indeed, it is highly possible that if you are trading forward contracts using a trading platform you might be handling futures contracts. Futures contracts can easily be standardized and made available to a large number of users.

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