Futures and forward contracts allow you to buy or sell a currency at a specified time in the future. However, these two agreements differ significantly when you consider their use, structure and more.
What are futures?
A futures contract is an agreement between parties to buy or sell a particular underlying asset at a specified rate and time in the future. They are traded on an exchange, so have clearing houses that guarantee the transactions.
Forwards – or forward contracts – are a private agreement between the buyer and seller to exchange the underlying asset for cash at a particular date in the future and at a set price. Forwards are settled at maturity, so the date the contract ends. Also, they are a private contract, so they’re not traded on an exchange.
How do futures and forward contracts differ?
Key differences between futures and forward contracts lie in their specificity, risk, transaction windows and goals.
Forward contracts
Futures contracts
Flexibility on terms and conditions
Private agreement between a buyer and a seller to sell an asset at a set price in the future, not necessarily on a set date. Because they are privately negotiated agreements, you often have more flexibility to customize the terms and conditions of your agreement.
Standardized agreement to buy or sell assets and commodities like currency at a set price or value on a specific date. Traded on regulated exchange. That structure leaves little room to change the underlying terms or conditions of the agreement. Instead, the buyer is obligated to take ownership of the asset the seller is providing on the contract’s settlement date — the date at which the contract expires.
Possibility of defaulting
Depends on each private party to fulfill their end of the agreement, leaving room for default if either the buyer or seller isn’t able to.
Traded on an exchange and backed by a clearing house. The support of that financial intermediary drops the risk of default significantly.
Window for fulfillment
Can close out the asset at its maturity or settlement date only.
Marked to market every day, meaning the value of the asset is appraised daily. You can close out your position in the agreement before the contract’s maturity.
Goals and returns
Typically used to insulate investment from fluctuations in a currency’s exchange rate.
Typically used by speculators looking to trade riskier currencies with the hope of large returns.
Do money transfer services offer futures contracts?
No, money transfer providers don’t offer futures contracts. This type of contract is mainly used by advanced investors to speculate on currency.
However, many online money transfer providers allow you to lock in an exchange rate using a forward contract. This tends to be offered as part of a suite of hedging tools designed to protect you against exchange rate fluctuations.
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A futures contract is best for advanced investors who can tolerate risk in the value of the asset they're looking to buy or sell. It gives them the framework of a regulated and standardized agreement. But for those looking to merely hedge or avoid volatility, then a private, more flexible forward contract is likely to be the better option.
Futures and forward prices differ because of how they trade. A forward contract is a private agreement, which is settled at maturity. Meanwhile, futures contracts are traded on an exchange and are marked-to-market daily. This means that daily changes are settled day by day until the end of the contract. Because of this difference, prices between the two can vary due to the effect of interest rates on the interim cash flows from the daily settlement.
Start with the mid-market rate between the two currencies you're trading. The mid-market rate is what your money's actually worth on the global market compared to another currency. It's the midpoint between worldwide supply and demand for that currency — and the rate banks and transfer services use when they trade among themselves. Use the mid-market rate as a baseline to compare against the rates provided by your bank or transfer service.
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Kevin Chen is a personal finance expert and a former writer at Finder. His expertise has been featured in CNN, U.S. News and World Report, Lifehacker and CreditCards.com, among other top media.
How do you know if your international money transfer made it safely? Learn how to track or cancel, and find out what your rights are when it comes to sending money.
From bank transfers to specialist money transfer companies, there are several options available when you need to transfer money overseas from your bank account.
If you need to transfer money overseas using your credit card, you can do so via your bank, MoneyGram, Western Union and PayPal. This can be useful in emergency situations, but credit card transfers are usually not a cost-effective option.
If you’re looking for a secure way to send money overseas, an international bank draft could be for you — but if speed is important, consider using a money transfer service instead.
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