Forward and futures contracts are commonly used in financial markets, but many people confuse them because they sound similar. In reality, there is a clear difference between forward and future contract in terms of how they are traded, regulated, and settled. These differences play an important role in business decisions, trading, and risk management.
In this blog, you will learn what forward and futures contracts are, how they work, and how they are different from each other.
A forward contract is a private agreement between two parties to buy or sell an asset at a fixed price on a future date. The price, quantity, and settlement date are decided at the time of making the contract. Forward contracts are not traded on stock exchanges. They are created directly between the buyer and the seller, which makes them flexible but less regulated.
In relation to the stock market and derivatives, forward contracts are part of the derivatives concept because their value depends on an underlying asset like shares, commodities, or foreign currency. For example, two parties can enter into a forward contract based on the price of a company’s shares, agreeing today on a price for future delivery.
However, in the Indian share market, forward contracts are not commonly traded on exchanges. Instead, futures contracts are used. Forward contracts are mostly used by companies and institutions for hedging purposes, not by retail investors, due to higher risk and lack of exchange support.
A futures contract is an agreement to buy or sell an asset at a fixed price on a future date, but unlike a forward contract, it is traded on a recognised stock exchange. In India, futures contracts are traded on exchanges like NSE and BSE. The exchange decides standard terms such as contract size, expiry date, and settlement rules. Because the exchange acts as a middle party, the risk of default is much lower.
In the stock market, futures contracts are widely used in the derivatives segment. For example, traders can buy or sell stock futures based on shares of companies like Reliance or TCS without owning the actual shares.
Futures are also available on indices like Nifty and Bank Nifty. To trade futures, traders must pay a margin amount instead of the full value, which allows them to take larger positions with less money. This makes futures popular among traders, but it also increases risk if the market moves in the opposite direction.
Although forward and futures contracts look similar at first, they are quite different in how they work in real markets. The main difference between forward and future contracts comes from where they are traded, how much flexibility they offer, and the level of risk involved.
Key differences between forward contract and future contract:
These points clearly show why futures contracts are more popular in the stock market, while forward contracts are mainly used by businesses for hedging purposes.
The difference between futures and forwards becomes much clearer when we look at practical examples. Real-life situations show how these contracts behave differently even when the goal is the same, which is fixing a price today for a future transaction.
Suppose an Indian wheat exporter expects to sell wheat after three months. The exporter enters into a forward contract with a buyer to sell wheat at a fixed price after three months. The agreement is made directly between both parties. If the market price changes later, the agreed price remains the same. However, if one party fails to honour the contract, there is no exchange support to handle the situation.
Now consider a stock market trader who believes the price of a Nifty index will rise next month. The trader buys a Nifty futures contract on the NSE. The contract terms are already set by the exchange. If the price moves up, the trader gains, and if it falls, the trader faces a loss. The exchange manages daily price changes and ensures settlement, making the process more transparent and reliable.
When comparing risk, between forward and future contracts it is mainly about safety and trust. Forward contracts involve direct dealing between two parties. If one party fails to complete the contract on the settlement date, the other party may face losses. Since there is no exchange supervision, this type of risk is higher and harder to manage.
Futures contracts are generally safer because they are backed by a stock exchange and a clearing system. The exchange ensures that both buyers and sellers meet their obligations through margin requirements and regular settlement. If prices move against a trader, losses are adjusted daily. This system reduces the chance of default, which is why futures contracts are widely preferred in the stock market and derivatives trading.
The choice between a forward and a futures contract depends on your purpose and how much risk you can handle. If you are a business owner, exporter, or importer who wants to lock a future price for planning purposes, a forward contract can be useful. It allows you to customise the terms according to your needs. However, you must be confident about the other party, as the risk is higher.
If you are a trader or investor in the stock market, a futures contract is usually the better choice. Futures are traded on exchanges, offer better safety, and are easy to buy or sell before expiry. They are suitable for people who want transparency, liquidity, and regulated trading in the derivatives market.
Advantages of Forward Contracts
Disadvantages of Forward Contracts
Advantages of Futures Contracts
Disadvantages of Futures Contracts
The difference between forward and future contracts lies mainly in how they are traded, managed, and regulated. Forward contracts are private agreements suited for businesses that need customised terms and price certainty. Futures contracts are exchange-traded instruments designed for transparency, liquidity, and lower default risk.
In the Indian market, forward contracts are mainly used for hedging by companies, while futures contracts dominate the stock market and derivatives trading. Choosing the right contract depends on your purpose, risk tolerance, and level of market participation.
A forward contract is a private agreement between two parties to buy or sell an asset at a fixed price on a future date. The contract terms are decided by both parties in advance, and it is not traded on a stock exchange. Forward contracts are mostly used by businesses to manage future price risk.
The main difference between forward and future contract is that forward contracts are private and unregulated agreements, while futures contracts are traded on stock exchanges. Futures contracts offer better safety and liquidity because they are backed by an exchange clearing system.
Forward contracts are generally not used in the Indian stock market by retail investors. The derivatives segment of Indian exchanges mainly uses futures contracts for trading shares and indices, as they are regulated and easier to trade.
Futures contracts are considered safer because they are traded on recognised exchanges that manage risk through margin requirements and daily settlement. This reduces the chance of default, which is higher in forward contracts.
Forward contracts are more suitable for businesses that need customised agreements to hedge price risk. Futures contracts are better suited for traders and investors who want transparency, liquidity, and regulated trading in the stock market.
Disclaimer: This article is intended for educational purposes only. Please note that the data related to the mentioned companies may change over time. The securities referenced are provided as examples and should not be considered as recommendations.
