Futures vs Forwards

A forward and a future do the same basic job: they lock in a price today for a trade that happens later. But they package it very differently, and those packaging choices matter more than beginners expect. A forward is a private handshake between two parties that settles just once, at the end. A future is a standardised contract you buy and sell on an exchange, and crucially, it settles the running profit or loss every single day. That one difference, daily settlement, cascades into everything else.

The core difference: daily settlement

With a forward, nothing happens between the day you sign and the delivery date. All the profit or loss lands in one lump at the end. With a future, the exchange marks your position to market at the close of each day: if the price moved your way, cash is credited to your account that evening; if it moved against you, cash is debited. By expiry, all those daily bits have already been paid, so the "final settlement" is just the last day's move.

The daily cash you must keep on deposit is called margin. You post an initial margin to open the position and must top it back up (a margin call) whenever losses eat into it. This is the same mechanism behind leverage and margin, and it's how the exchange protects itself.

The trade-offs, side by side

	Forward	Future
Where it trades	Private (over-the-counter)	Exchange
Terms	Custom (size, date, asset)	Standardised
Settlement	Once, at expiry	Daily mark-to-market
Credit risk	Full exposure to the other party	Clearinghouse guarantees both sides
Cash before expiry	None	Margin posted and topped up daily
Liquidity	Hard to exit early	Easy to close by trading the offset

The exchange stands between buyer and seller (it novates the trade), so you never worry about who's on the other end, the clearinghouse guarantees it, backed by everyone's margin. That's the big win of futures over forwards: counterparty risk almost vanishes. The cost is that you must fund margin along the way, and a violent move can trigger a cash call before the trade has even "finished."

Worked example

You go long one equity-index future at 5,000, with a contract multiplier of $50 per point. Watch three days:

• Day 1: the index closes at 5,020, up 20 points. The exchange credits your margin account by $20 \times 50 = 1{,}000$ dollars that evening.
• Day 2: it drops to 4,990, down 30 points from the prior close. You're debited $30 \times 50 = 1{,}500$ dollars. If that pushes your balance below the maintenance level, you get a margin call and must wire cash in.
• Day 3: it recovers to 5,010, up 20 points. You're credited another $1,000.

Add the daily marks: $+1000 - 1500 + 1000 = +500$, which is exactly $(5010 - 5000) \times 50$. A forward on the same index would have paid you that same $500, but all at once at expiry, with nothing changing hands on days 1 and 2. Same destination, very different journey.

The subtle price gap

If futures and forwards are so similar, do they cost the same? Almost, but not exactly. The gap comes from reinvesting the daily marks. When interest rates move together with the underlying, the daily cash flows of a future get reinvested at systematically helpful or harmful rates. If the underlying tends to rise when rates rise, a long future's gains land in your account exactly when they can be reinvested at higher rates, a small edge, so the futures price sits a touch above the forward price. When rates and the underlying are uncorrelated, this effect washes out and the two prices are equal, a classic result of Cox, Ingersoll and Ross.

Common pitfalls

• Ignoring the funding of margin. A profitable forward costs nothing until expiry; a profitable future still forces you to fund losses day by day before the winning days arrive. Treasurers care about this cash timing even when the final P&L is identical.
• Assuming zero counterparty risk on a forward. Over-the-counter forwards carry the full credit risk of the other side. The 2008 crisis was, in part, a lesson in what happens when those private promises can't be kept.
• Forgetting the convexity gap on rate products. For most equity and commodity contracts the futures-forward gap is negligible. For interest-rate futures it's a real, hedged-for adjustment called the convexity correction, don't assume it's zero there.