Futures Contract vs. Forward: Why Futures Are a Better Choice
When it comes to hedging against market risks, many traders often have to choose between futures and forward contracts. While both these trading instruments are similar in many aspects, there are some key differences that set them apart. In this article, we will explore why futures contract is a better choice than forward.
Futures contracts are standardized and traded on regulated exchanges
One of the significant advantages of futures contracts over forward contracts is their standardization. Futures contracts are traded on regulated exchanges, and their terms and conditions are predetermined. This means that buyers and sellers don`t have to negotiate the details of the contract, making trading less complicated.
In contrast, forward contracts are private agreements between two parties, and their terms and conditions are decided upon by the parties involved. This makes forward contracts less transparent, and they are not traded on exchanges, making them more challenging to trade.
Futures offer liquidity and higher trading volume
Another advantage of trading futures contract is the liquidity and higher trading volume. Futures contracts have a more significant trading volume, making it easier for traders to enter and exit positions quickly. Plus, futures contracts are settled daily, meaning that traders can receive or pay the gains or losses on a daily basis, which is not possible in forward contracts.
In contrast, forward contracts are not settled daily, and there is no secondary market for them. This means that the parties involved can`t exit their positions until the contract`s expiration date.
Futures contracts offer greater price transparency
Futures contracts offer greater price transparency, making it easier for traders to hedge their positions efficiently. As mentioned earlier, futures contracts are traded on regulated exchanges, and their prices are publicly available. This allows traders to see the market`s expectations regarding a particular commodity or asset, which helps them make more informed decisions.
In contrast, forward contracts are private agreements, and their prices are not publicly available. This makes it challenging for traders to know if the price they are paying or receiving is fair or not.
Conclusion
While both futures and forward contracts serve the same purpose of hedging risks, futures contracts offer more advantages than forward contracts. They are standardized, traded on regulated exchanges, have high liquidity, and offer greater price transparency. These advantages make trading futures contracts easier and more efficient than forward contracts. Therefore, if you are looking to hedge your market risks, futures contracts are a better choice than forward contracts.