Futures and forwards
Also known as: futures contracts and forward contracts
Futures and forwards are derivative contracts obligating two parties to buy and sell an asset at a set price on a future date. Futures are standardized and exchange-traded, while forwards are private, customizable agreements.
Futures and forwards are derivative contracts in which one party agrees to buy, and the other to sell, an underlying asset — a commodity, currency, index, or financial instrument — at a price fixed today, with delivery and payment on a future date. Unlike options, both parties are obligated to perform; neither side can simply walk away if prices move against them.
The two differ in structure. Futures are standardized contracts traded on exchanges: contract size, delivery dates, and quality specifications are set by the exchange, and a clearinghouse guarantees performance, virtually eliminating counterparty risk. Positions are marked to market daily and can be closed before delivery with an offsetting trade. Forwards are private, negotiated agreements between two parties — every term is customizable, but there is no clearinghouse, so each side bears the risk that the other defaults, and positions are difficult to exit before settlement.
Both contracts serve hedgers and speculators. A wheat farmer can lock in a sale price months before harvest, and an importer can fix an exchange rate for a future payment. Speculators take the other side, seeking profit from price movements. Because obligations are binding and losses are potentially unlimited, these instruments suit only investors who understand and can bear the risk.
The Series 65 and Series 66 exams test futures and forwards within their derivatives material, including the standardized-versus-customized contrast, the role of the clearinghouse, and suitability — knowing which clients these contracts are appropriate for is as important as knowing how they work.
Key takeaways
- Futures and forwards obligate both parties to transact at a set price on a future date — unlike options, there is no right to walk away.
- Futures are standardized, exchange-traded, and cleared through a clearinghouse, which nearly eliminates counterparty risk.
- Forwards are private, fully customizable contracts that carry counterparty risk and are hard to exit before settlement.
- Hedgers use these contracts to lock in prices; speculators use them to profit from price movements.
- The Series 65 and 66 exams test the futures-versus-forwards contrast and the suitability of derivatives for different clients.