Difference Between Forwards and Futures Contract
- 17th July 2025
- 10:30:00 AM
- 7 min read
If you have begun exploring derivatives, you have likely come across forwards and futures, two powerful tools for hedging and risk management. With Indian derivative traders rising to 96 lakh in FY25 from 86.3 lakh in FY24, the interest of traders is growing fast.
However, many still struggle to differentiate the two. While forwards are private and customisable, futures are standardised and traded on exchanges. This blog breaks it down, helping you understand the differences between forward and futures contracts.
Forward vs Futures Contract: Key Differences
Forward and futures contracts help in hedging and speculation. Key differences include counterparty risk, standardisation, and trading venues. For instance, futures are exchange-traded and marked to market daily, while forwards are private agreements.
The table below highlights some key differences between forward and futures contracts based on several parameters:
| Parameters | Forward Contract | Futures Contract |
| Standardisation | Forward contracts are bilateral contracts that may be customised. | Futures have standardised terms that are specified by the exchange for consistency and a predetermined lot size. |
| Trading | Forward contracts are private and flexible and are useful for hedging. | Futures are traded on exchanges with daily price adjustments. |
| Participants | Producers, speculators, and consumers frequently utilise forward contracts. | Institutional and individual investors use futures. |
| Costs | Forward contracts involve lower transaction costs. | Broking, exchange fees, and margin requirements are all involved in futures contracts. |
| Margin requirements | A forward contract does not require collateral since the parties negotiate the contract. | Since the parties must deposit an initial margin and maintain a maintenance margin to offset prospective losses, a futures contract contains a collateral requirement. |
| Regulations | Forward contracts do not come under any regulation. | The Securities and Exchange Board of India (SEBI) regulates the futures contracts. |
| Price determination | The parties in the contract determine the price of forward contracts. | Open market forces determine the price of a futures contract. |
| Signing | A forward contract is signed in person or over the counter between two parties. | A futures contract is signed through an intermediary or exchange. |
| Risks | Forward involves high bilateral default risk. | Due to the exchange clearinghouse, futures involve minimal risk. |
| Maturity | Forward contracts are scheduled to mature on the date specified in the private contract. | Futures contracts mature on a predetermined date. |
| Settlement | The parties may negotiate the conditions of the settlement. They settle forward contracts when they mature. | Futures contracts are settled by the exchange every day. |
| Transparency | Forward contracts have no liquidity or transparency as they are private agreements. | Futures contracts are transparent and liquid as they are traded on the stock exchanges. |
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Understanding a Forward Contract
A forward contract is a privately negotiated agreement between two parties to buy or sell an underlying asset at a specific price on a future date. These contracts are typically traded over the counter (OTC) and are commonly used in markets like commodities, currencies, and raw materials.
One of the key advantages of forward contracts is their flexibility. The terms, such as the type and quantity of the asset, delivery date, and settlement conditions, can be customised to suit the needs of both parties.
The primary goal of forward contracts is to hedge against price fluctuations. Businesses often use them to lock in prices for essential inputs like commodities or foreign currencies, ensuring cost predictability and stability in their procurement processes.
Example of a Forward Contract
Suppose you want to sell lentils, and the current market price is INR 148 per kg. You anticipate that prices may fall in the next month due to market conditions. To avoid potential losses, you enter into a forward contract with a supermarket.
As per the agreement, you will sell lentils at INR 148 per kg one month later, regardless of market price fluctuations. If the market price drops below INR 148, you are protected and will not incur a loss. However, if prices rise above INR 148, you will still receive only the agreed amount, missing out on any additional profit.
Understanding a Futures Contract
A futures contract, like a forward contract, is an agreement between two parties to buy or sell an asset at a predetermined price on a specified future date. However, unlike forward contracts, futures are traded on organised exchanges or through intermediaries, making them standardised and regulated.
Futures contracts cover a wide range of underlying assets such as stocks, bonds, commodities, and currencies. As a buyer, you do not need to pay the full contract value upfront. Instead, a margin or collateral is required, offering leverage.
The delivery date, transaction volume, credit process, and other technical details are typical terms and conditions of a futures contract. Since futures contracts involve brokerage, margin requirements, and exchange fees, your overall profit may be slightly reduced compared to private agreements. However, the transparency and reduced counterparty risk offer significant advantages.
Example of a Futures Contract
Imagine you plan to sell lentils, and your friend Amit owns a supermarket that regularly stocks them. You both agree to enter into a futures contract for 50 kg of lentils at a fixed price of INR 148 per kg, with delivery scheduled for a future date.
Hence, no matter what the market price is at the time of delivery, the contract will be executed at INR 148 per kg. If the market price rises to INR 160 per kg, Amit benefits by paying less than the market rate, gaining INR 12 per kg. However, if the price drops to INR 140 per kg, you benefit by selling above the market price, earning INR 8 more per kg.
This contract helps both parties manage price risk while locking in predictable costs or revenues.
Final Thoughts
Both futures and forward contracts are beneficial to protect your portfolio against price movements. The differences between forward and futures contracts entail that forward contracts are customisable, involving two parties and futures offer standardised contracts. Since the exchanges control the futures, they carry less risk than forwards.
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Frequently Asked Questions
1. Who creates futures contracts?
The regulated exchanges create futures contracts. Consequently, it is the exchange’s responsibility to standardise each contract’s requirements.
2. Is it possible to settle forward contracts before maturity?
No, settlement takes place on the forward contract’s maturity date. The party who owes the difference often pays the other party after comparing the agreed-upon price with the going rate.
3. How does margin differ for forward and what does it mean in futures contracts?
In futures contracts, a margin is the initial deposit required to enter a trade, with a maintenance margin needed to keep it open. It reduces default risk. In contrast, forward contracts are private agreements and typically do not require margins, as risk is managed based on mutual trust and agreement.
4. Based on the differences between forward and futures contracts, which one is riskier?
Forward contracts pose a default risk since one of the parties might not provide the products or the money. Contrarily, since they guarantee payment on the scheduled date, futures have significantly lower counterparty risk.
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Disclaimer: This blog has been written exclusively for educational purposes. The securities mentioned are only examples and not recommendations. It is based on several secondary sources on the internet and is subject to changes. Please consult an expert before making related decisions.
