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.
Futures contracts are standardized and traded on exchanges with daily settlements, while forward contracts are private, customizable agreements settled at maturity.
This article delves into these key differences.
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.
Types of underlying assets include:
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.
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. |
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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