Articles

Comparison of Forward Contracts and Futures Contracts

Jul 3, 2025

Forward contracts and futures contracts are two important tools in the derivatives market. While both allow parties to trade and buy underlying assets at a specified future date, each contract type has its own unique characteristics and benefits. To understand what a forward contract is and how it differs from a futures contract, this article will guide you through the features, advantages, disadvantages, and risks of investing in these two types of contracts. Let’s explore with SFVN to choose the most suitable derivative investment strategy!

Forward contracts and futures contracts help hedge risks and optimize investment profits

What is a Forward Contract?

A forward contract is a derivative financial instrument that allows two parties to agree to buy or sell an underlying asset, such as commodities or foreign currency, at a predetermined price on a specific future date. Traded on the over-the-counter (OTC) market, forward contracts offer high flexibility, allowing both parties to adjust terms such as price, quantity, quality, and delivery time without following standardized regulations. This also means that price and transaction terms are kept private, not publicly disclosed on the market.

Forward contracts offer flexibility, security, and are suitable for transactions requiring specific conditions

What is a Futures Contract?

A futures contract is a type of standardized forward contract traded publicly on centralized exchanges. Futures contracts are characterized by predefined terms such as size, delivery time, and quality standards of the underlying asset, which are set by the exchange, making it easier for investors to access and transfer contracts when needed. The value of a futures contract is public and determined through the auction mechanism on the exchange, offering more transparency than forward contracts.

Futures contracts allow investors flexible trading with high transparency and liquidity

Comparison of Similarities and Differences between Forward and Futures Contracts

Similarities between Forward and Futures Contracts:

Derivative Instruments: Both forward and futures contracts are derivative financial instruments that allow two parties to commit to buying or selling an underlying asset in the future at a pre-agreed price.
Usage Purpose: Both types of derivative contracts can be used to hedge against price fluctuations of the underlying asset or to speculate for profit from price differences.
Underlying Assets: Both contracts can be applied to a wide range of underlying assets, including commodities (such as oil, metals, and agricultural products), securities, foreign currency, and other financial indices.

Differences between Forward and Futures Contracts:

Characteristic	Forward Contract	Futures Contract
Trading Venue	Over-the-counter (OTC) market	Centralized commodity exchange
Standardization	Non-standardized, terms are privately agreed upon between the two parties	Standardized in terms of size, maturity, quality by the exchange
Contract Size	Flexible, as agreed upon between both parties	Fixed as per exchange regulations
Trading Price	Privately negotiated, not publicly disclosed	Publicly available and determined through the auction mechanism on the exchange
Settlement	Settlement on the expiration date upon delivery of the asset	Daily settlement via mark-to-market mechanism
Transferability	Low, only transferable with mutual consent	High, easily transferable due to centralized trading and high liquidity
Liquidity	Low, limited participation	High, with many participants
Margin Requirement	No margin requirement, depends on mutual agreement	Requires initial and maintenance margin, adjusted as the market fluctuates
Transaction Management	Typically lacks strict regulatory oversight	Strictly regulated by regulatory bodies and the exchange
Credit Risk	High, no clearinghouse guarantee	Low, with a clearinghouse guarantee on the exchange
Primary Purpose	Mainly for delivery of assets upon maturity	Primarily for closing positions before maturity to profit from price differences
Example	Two parties agree to buy/sell oil at a fixed price on a specific future date	Crude oil futures contract traded on NYMEX with standardized terms

Should Investors Choose Forward Contracts or Futures Contracts?

Choosing between a forward contract and a futures contract depends on the investor's goals, need for flexibility, and risk tolerance. Here are some suggestions to help investors identify the right type of contract:

Goal of Protecting Asset Value or Specific Risk Hedging: If an investor requires a flexible solution with customizable terms based on private agreements, a forward contract will be a suitable choice. This type of contract allows the parties to tailor transaction conditions to meet specific needs, such as unique commodity quantities or differing delivery times.
Goal of Short-Term Speculation and High Liquidity Needs: Futures contracts, with their high liquidity and ease of buying and selling on exchanges, are ideal for speculators. Futures contracts suit those who want quick trading, benefiting from short-term price fluctuations without needing to take physical delivery upon contract maturity.
Credit Risk Tolerance: Investors concerned about credit risk can choose futures contracts, as the exchange and clearinghouse ensure safety and minimize counterparty risk. In contrast, forward contracts generally have higher credit risk due to a lack of third-party guarantees.

Overall, forward contracts are suitable for customized, less liquid transactions, while futures contracts are ideal for investors needing high liquidity and security from the exchange. Investors should consider these factors to select the contract type that aligns with their investment strategy.

Futures contracts offer greater flexibility, higher liquidity, and lower investment risk compared to forward contracts

Conclusion

Forward contracts and futures contracts are two essential tools in the derivatives market, providing investors with methods for risk management and profit speculation. To make the most of the benefits and mitigate risks, investors need to understand each contract type, advantages and disadvantages of forward contracts and futures contracts, and potential risk factors. Open a derivatives trading account with SFVN today!