Connect with us


Choosing Between Forward Contracts & Futures Contracts



Choosing Between Forward Contracts & Futures Contracts

Photo by Ivan Babydov from Pexels

As we are talking about cryptocurrency, we are sure you have heard about smart contracts, but they aren’t the only contracts in the crypto world.

This is because there are futures contracts and forward contracts, which are being populated right now, probably because of the mainstream adoption and acceptance of the cryptocurrency that made Bitcoin a legal tender in El Salvador. So, with this article, we are focusing on the differences between forward contracts and futures contracts, as well as exploring the exciting realm of crypto derivatives trading, to help you make the right choice.

Forward Contracts

Forward contracts are the agreements applied between two parties for selling or purchasing the specific product, respective to the predetermined strategies and terms, and the delivery and payment are completed at a later date. The contract terms are negotiated through the individual parties.

When it comes down to the crypto world, forward contracts are concluded outside the exchange platforms which is called crypto OTC, Over Counter transaction.

The forward contracts allow the traders to hedge against the drastic fluctuations in the future price. When you are taking a short position, the forward contracts holder will have to hedge against the falling processes.

On the other hand, the long position allows the holders to fight against the rising process. In the traditional currency markets, the forward exchange contracts are suitable for selling and buying currency, and the fulfillment is completed on the agreed terms.

The forward contracts have the capacity of speculating the exchange rate changes; it also determines if the companies need to hedge the exchange rate to determine the value of future transactions. It wouldn’t be wrong to say that it allows the companies to secure the currency at the current rate while the delivery fee is left for later.

Futures Contracts

The futures contracts are defined as the transactions conducted and traded between two parties, seller and buyer. It is done in a regulated and well-organized futures market.

Whenever you have to purchase the futures contract, the holders are obliged to sell and purchase the underlying assets at a specific rate and at a specific time, which is known as the settlement date. The value of the futures contract is calculated daily on the market prices.
The futures contracts are fully regulated and traded on well-established exchanges. When it comes down to the applications, it’s used for hedging as well as speculation.

The futures contracts were initially designed for the agricultural markets, and the primary function was to reduce the risk of loss associated with the fluctuations in the asset price. For those who don’t know, futures contracts are suitable for trading on the official exchanges.

However, they are also suitable for two other roles. To begin with, futures contracts can help with the price discovery process, and it also represents the opinion consensus on the specific price that’s likely to be reached at a specific time.

The second role is their ability to increase liquidity, which allows seamless execution of the bigger orders while ensuring limited fluctuations in the price.

Differences Between Futures Contracts & Forward Contracts

As we have already shared information on the basic concept of these contracts, it is important to understand the underlying differences between them, and the following factors make them unique from each other.

The Transaction Method

The future contracts are designed to be traded on the formal platforms, and they are standardized at different rates, including nominal value, tick size, and contract size. On the other hand, forward contracts have private negotiation and are personalized according to the preferences of their counterparts.

Risk Level

The futures aren’t prone to counterparty risks and are regulated by different financial authorities. As far as the forward contracts are concerned, they tend to pose default risks because of private negotiations and depend on the payment.

Contract Maturity

The future contracts come with the fixed maturity timing, which is set by the exchange at regular intervals. On the other hand, the forward contracts can be customized for any date, depending on the agreement between different parties.

The Bottom Line

Be it the futures contracts or forward contracts, both of them are meant to allow negotiations and are called derivatives as the price fully depends on the spot price evolution. So, which of these are your preferred choices?

Click to comment

Leave a Reply

Your email address will not be published. Required fields are marked *