Forward versus future: five key differences
| Feature | Forward | Future |
|---|---|---|
| Trading venue | Private (OTC) | Exchange-traded |
| Standardization | Customizable terms | Standardized contracts |
| Counterparty risk | High — depends on the other party | Low — clearinghouse guarantees |
| Settlement | At expiration only | Daily mark-to-market |
| Liquidity | Low — hard to exit early | High — active secondary market |
Why no cash changes hands upfront
The key insight: neither party pays anything upfront in a forward/future. Both sides lock in a price today for delivery tomorrow. This makes them powerful hedging tools — and powerful speculative instruments.
Who hedges with futures, and how
Think about a commodity (oil, wheat, gold). If you were a farmer, you’d sell futures to lock in today’s price for next year’s harvest. If you were an airline, you’d buy fuel futures to lock in costs.
How a locked hedge plays out
An airline buys jet fuel futures at $2.50/gallon. The spot price at delivery is $3.00. What’s the result?
Hedgers, not speculators, dominate futures
Hedging locks the price, both ways
A corn producer hedges 1M bushels at $5/bushel with forwards expiring in 6 months. At expiry, spot is $7/bushel. What's the P&L vs. not hedging?
Check your understanding
Sit with the ideas.
An airline wants to lock in jet fuel prices for the next 12 months. It enters a futures contract to buy fuel at $2.50 per gallon. Spot fuel prices rise to $3.20 per gallon by delivery. What is the airline's effective cost?
Why: