Difference between forwards and futures: which derivative should a trader choose?

When it comes to trading derivatives on the crypto market, traders are often faced with a choice: forward or futures contracts? Although both instruments allow speculation on price fluctuations without owning the actual asset, their mechanics differ significantly. Let’s explore the key differences.

History and essence of forward agreements

Forward agreements are one of the oldest financial instruments in the world. They originated centuries ago when farmers and merchants needed to hedge against unpredictable changes in the value of their produce. Today, companies still use such agreements for risk hedging.

A forward contract is a private agreement between two parties to buy or sell an asset in the future at a price set today. For example, an airline and a jet fuel producer might agree directly: the airline will buy fuel at $11 per gallon in six months, although the current price is only $10. If the price rises to $12 in six months, the airline wins — purchasing cheaper than the market. If it drops to $9, the airline loses, paying more.

How the forward market is structured

This market is characterized by flexibility. The parties to the agreement independently determine all parameters: which asset to exchange, at what price, and when to settle. Such agreements are concluded over-the-counter (OTC) — meaning private communication between participants without platform intermediaries. No one controls the process except the parties themselves, who bear legal responsibility to each other.

Advantages for participants

Forward contracts are attractive to companies for several reasons. First, no advance payments are required — parties settle only on the day of execution. Second, full flexibility in choosing terms allows tailoring the agreement to specific needs. Third, the over-the-counter format ensures confidentiality of the operation.

Risks and limitations

However, such agreements have serious drawbacks. The main one is counterparty risk, i.e., the probability that one party will not fulfill its obligations. Additionally, forward agreements suffer from low liquidity — finding a willing buyer or seller for such an agreement can be difficult, making exit from the position problematic.

Futures contracts: standardization on exchanges

Unlike forwards, futures contracts are standardized agreements traded on public exchanges. Their parameters are predetermined by the exchange itself: the asset, contract size, settlement date, price. Traders can open long (buy) or short (sell) positions, speculating on the change in the value of Bitcoin and other assets.

The role of the clearinghouse in futures trading

The key difference is the presence of an intermediary. When a trader and counterparty enter into a futures contract, the clearinghouse acts as an intermediary. It verifies both sides’ data and guarantees the execution of the agreement. This significantly reduces counterparty risk.

Moreover, the clearinghouse requires traders to deposit margin — an initial and maintenance amount necessary to cover potential losses. If the balance drops below the minimum, the trader receives a margin call — a requirement to top up funds. Failure to do so results in automatic position closure.

Advantages of futures agreements

Standardization makes futures contracts attractive to many traders. First, all information about underlying assets and settlement terms is open and transparent, creating a fairer environment. Second, the clearinghouse guarantees contract fulfillment according to specified deadlines, minimizing risks. Third, high liquidity allows traders to quickly exit their positions if they need to change strategy.

Disadvantages and costs

On the other side of the scale are costs. Daily settlement of differences between accounts generates additional commission fees. Additionally, low flexibility means traders cannot choose the underlying asset at will — the exchange offers a limited set. The contract size, price, and commissions are also determined by the exchange, not the participants.

Comparative analysis: which agreement for whom?

Forward and futures contracts serve different purposes:

Forward agreements are suitable for companies seeking to secure the supply of goods cheaply and willing to accept counterparty risk for flexibility and confidentiality.

Futures contracts are tools for traders who want to quickly speculate on price fluctuations with minimal counterparty risk but are ready to pay commissions and accept strict exchange conditions.

Forward contracts do not require margin deposits at the start — settlement occurs only at the end of the term. Futures, however, require both initial and maintenance margins, which are revalued daily.

Frequently asked questions by traders

Why is the forward market unregulated, but the futures market is?

The forward market involves private agreements, so regulation is fundamentally impossible. Futures contracts are traded on public exchanges and are subject to oversight by regulators (in the US, this is CFTC or SEC).

Which agreement should I choose for physical delivery of the asset?

A forward agreement is more advantageous if you truly need the asset. It is cheaper to hold and allows parties to agree on precise delivery terms.

How do forward contracts differ from options?

A forward contract obligates both parties to fulfill the agreement. An options contract gives the right, but not the obligation, to execute the deal — the option holder can refuse.

Both types of derivatives are valid depending on the trader’s goals and risk strategy.