Futures vs. Forwards

Commodities

A commodity is a raw material or agricultural product with economic value.

Common commodities include:

Commodity prices fluctuate regularly, much like stock prices. That price movement creates both opportunity and risk:

• Investors may speculate on commodity prices, aiming to profit if their price prediction is correct.
• People and businesses that work directly with commodities (for example, farmers, distributors, and miners) often want to reduce the impact of price swings, so they hedge their risk.

Definitions

⚠️ 🔑 GUARANTEED EXAM TABLE — Futures vs. Forwards

Futures contracts

Futures contracts set a “locked-in” price today for a future transaction involving a commodity, foreign currency, or other financial asset.

🔑 Similarities futures share with options

Standardization / contract size

Like stock options, which typically represent 100 shares per contract, futures contracts cover a specified quantity of a commodity. The exact quantity depends on the commodity, but it’s the same for every contract of that type.

For example, a milk futures contract covers delivery of 200,000 pounds of milk. Every milk futures contract covers the same amount, which is what it means for the contract to be standardized.

Obligations

Worked example — live cattle futures

Futures contract for 20 tons of live cattle at $3.

This futures contract would result in:

Futures buyer: obligation to buy 20 tons @ $3/pound Futures seller: obligation to sell 20 tons @ $3/pound

Closing out vs. delivery

In practice, the buyer could hold the contract through settlement and actually take delivery of 20 tons of live cattle. However, the vast majority of futures contracts are closed out before that happens.

• Closing out means the buyer sells the contract before the delivery date, which removes the buyer’s obligation to purchase.
• The seller typically exits by buying back the contract before the delivery date, which removes the seller’s obligation to sell.

Speculation and hedging with futures

Because most futures positions are closed out rather than settled with delivery, futures are often used primarily for speculation. That said, futures can also be used to hedge.

For example, an investor holding a significant amount of oil company stock might sell oil futures. If oil prices fall and the stock declines, the short oil futures position (bearish on oil) can gain value and help offset the stock losses.

Futures can also be used to hedge foreign currency risk. For example, a company expecting to pay a supplier in euros could use euro futures to hedge against exchange-rate fluctuations.

Liquidity

Futures trade on exchanges and typically have low liquidity risk. Standardization helps liquidity: when contracts have consistent terms, market participants can buy and sell them more easily. If every contract were customized, traders would need to evaluate unique terms each time, making active trading much harder.

🔑 Futures — important test points

• Standardized contracts to perform a future transaction at a fixed price
• Buyer has obligation to buy (bullish)
• Seller has obligation to sell (bearish)
• Trade on futures exchanges (high liquidity)
• Utilized primarily by speculators

Forward contracts

Forward contracts also set a “locked-in” price today for a future transaction involving a commodity, foreign currency, or other financial asset.

Similarities to futures

So the purpose (a future commodity transaction at a set price) and the obligations of the buyer and seller are the same.

🔑 Differences from futures

Unlike futures, forward contracts are customized to match what the buyer and seller actually need.

Worked example — corn farmer and distributor

Suppose a corn farmer expects a harvest of 2.5 metric tons and plans to deliver the corn to a cereal distributor. Both parties are exposed to price risk:

If favorable weather creates an oversupply of corn, corn prices could fall, hurting the farmer. If poor conditions create a shortage of corn, corn prices could rise, hurting the distributor.

To hedge against price changes before harvest, the farmer and distributor could enter into a forward contract. Because it’s non-standardized, they can choose a custom quantity (2.5 metric tons) and a custom delivery date.

Forward contracts are also commonly used with foreign currencies. For example, a business expecting to receive payment in a foreign currency could enter into a forward contract to lock in an exchange rate prior to receiving the payment.

Foreign currency forward example

Forward contracts are commonly used in foreign currency markets.

A U.S. company expects to receive €1 million from a European customer in 90 days. The company is concerned that the euro may decline relative to the U.S. dollar before payment is received.

To hedge this risk, the company could enter into a forward contract to lock in an exchange rate today for the future conversion of euros into dollars.

If the euro declines, losses from the currency movement may be offset by gains in the forward contract.

Like commodity forwards, currency forward contracts are typically customized to match the amount and timing needed by the parties involved.

Liquidity and settlement

🔑 Forwards — important test points

• Customized contracts to perform a future transaction at a fixed price
• Buyer has obligation to buy (bullish)
• Seller has obligation to sell (bearish)
• No trading market (low liquidity)
• Utilized primarily by those working directly with commodity

Key points

Futures contracts

• Standardized contracts to perform a future transaction at a fixed price
• Buyer has obligation to buy (bullish)
• Seller has obligation to sell (bearish)
• Trade on futures exchanges (high liquidity)
• Utilized primarily by speculators

Forward contracts

• Customized contracts to perform a future transaction at a fixed price
• Buyer has obligation to buy (bullish)
• Seller has obligation to sell (bearish)
• No trading market (low liquidity)
• Utilized primarily by those working directly with commodity

Sources

Primary/official references for the material in this chapter. Every link was fetched and returned HTTP 200 on 2026-08-15.