Futures vs Forwards: Standardised vs Custom, Exchange vs OTC, and Who Carries the Risk

Futures and forwards are both agreements to buy or sell something at a price fixed today for settlement on a later date. The difference is how they are built: a futures contract is standardised, traded on an exchange, guaranteed by a clearing house, and settled in cash every day, while a forward is a private contract negotiated between two parties, usually settled only once, at the end.

In short: a forward is custom-made and private, so it fits the need exactly but exposes each side to the other’s credit risk and is hard to exit early. A futures contract is off the rack: fixed sizes and dates, traded on an exchange, with a clearing house in the middle and daily mark-to-market, which nearly removes counterparty risk but creates daily cash flows and a less exact fit. Over the life of the contract the total gain or loss is about the same; what changes is who you depend on and when the money moves.

The misconception: “they’re the same thing with different names”

Economically, a forward and a futures contract on the same asset, for the same date, at the same price, produce nearly the same final profit or loss. That is why textbooks often treat them together. But a corporate treasurer, a farmer, or a fund manager experiences them very differently, because the plumbing is different: legal terms, credit exposure, cash flows, and the ability to close the position.

Side by side

Feature	Forward	Futures
Where it trades	Over the counter (OTC), directly with a bank or dealer	On an exchange such as CME Group, ICE, or the Montréal Exchange
Terms	Negotiated: any amount, any date, any delivery point	Standardised by the exchange: fixed size, months, grades, last trading day
Counterparty	The other party to the contract	The clearing house, after novation
Credit risk	You depend on the other side paying	Very low, backed by margin and clearing house resources
Collateral	Whatever the parties agree, often under a credit agreement, sometimes none	Initial margin plus daily variation margin, set by the clearing house and broker
Cash flows	Usually one settlement at maturity	Gains and losses settled at least daily
Exiting early	Negotiate with the same counterparty, or enter an offsetting forward	Do the opposite trade on the exchange at the market price
Price transparency	Quoted by the dealer, not public	Public prices and daily settlement prices
Delivery	Usually delivered or cash settled as agreed	Most positions are closed before expiry

Standardised vs bespoke

A forward can be cut to fit. A Canadian manufacturer that will receive exactly US$1,237,500 on March 14 can sign a currency forward with its bank for exactly that amount and that date.

A futures contract comes in fixed sizes. CME’s Canadian dollar futures, for example, are for C$100,000 per contract and expire on set dates in a quarterly cycle. A company hedging an odd amount on an odd date has to use the nearest whole number of contracts and the nearest month, accepting a small mismatch. That leftover mismatch is a form of basis risk, covered in how hedging with futures works.

The trade-off runs the other way for liquidity. Because every contract with the same symbol is identical, thousands of participants can trade it, and anyone can close a position at the market price. A bespoke forward can only really be unwound with the counterparty who wrote it.

Exchange vs OTC, and counterparty risk

With a forward, your protection is the other side’s creditworthiness and whatever collateral agreement you signed. If your bank or trading partner fails while the contract is in your favour, you become an unsecured creditor for the gain.

With futures, the trade is novated to the clearing house the moment it is accepted for clearing. CME’s rules describe the clearing house as substituting itself as buyer to the seller and seller to the buyer. The clearing house in turn collects margin from every clearing member and keeps guarantee funds behind that. The mechanics are in how clearing houses work.

Futures do not remove every credit risk. You still depend on your broker (the futures commission merchant in the US, or investment dealer in Canada) to hold your money properly, which is why customer fund protection matters.

Daily settlement vs settlement at maturity

This is the difference people underestimate. A forward’s gain or loss is mostly on paper until maturity. A futures contract is marked to market every day: the exchange sets a settlement price, and cash moves between accounts based on the change. A loss today has to be paid today, even if the price recovers by expiry. The arithmetic of that is in how futures margin works.

A worked example: one hedge, two instruments

A Canadian exporter expects to receive US dollars in three months and wants to protect itself against the Canadian dollar rising (which would mean fewer Canadian dollars for each US dollar received). The cleanest way to see the cash flow difference is in terms of Canadian dollars bought. All rates are illustrative.

The exporter wants to lock in buying C$1,000,000 at 0.7300 US dollars per Canadian dollar.

Option 1: a forward with its bank. The exporter agrees to buy C$1,000,000 for US$730,000 in three months. No money changes hands until then (assume no collateral agreement).

Option 2: futures. The exporter buys 10 CME Canadian dollar futures (10 x C$100,000) at 0.7300.

Now suppose the Canadian dollar first falls to 0.7150 after six weeks, then rises to 0.7450 by the settlement date.

Point in time	CAD rate	Forward: cash moved so far	Futures: cumulative variation margin
Start	0.7300	$0	$0
Six weeks	0.7150	$0	minus (0.7300 minus 0.7150) x 1,000,000 = minus $15,000
Settlement	0.7450	gain of (0.7450 minus 0.7300) x 1,000,000 = $15,000, received at maturity	plus $30,000 over the second half, net plus $15,000

The final result is the same $15,000 gain either way, before costs. But the futures user had to pay $15,000 in cash during the dip, while the forward user paid nothing. A business with tight cash flow can find that the futures hedge creates a funding problem in the middle, even though the hedge works in the end. Conversely, the futures user never had to worry about the bank failing while owing it $15,000.

(Strictly, futures and forward prices can differ slightly because daily settlement lets futures gains be reinvested and losses be financed at changing interest rates. For most practical purposes the difference is small.)

A second example: a farmer’s forward with the local elevator

Most farmers who lock in a price never touch the futures market themselves. They sign a forward contract (often called a cash contract) with the grain elevator or processor they normally deliver to. All prices below are illustrative.

In June, a farmer agrees to deliver 10,000 bushels of corn to a local elevator in November at $4.30 a bushel. The elevator quotes that price as December corn futures at $4.50 minus a local basis of 20 cents. The forward fits the farmer exactly: the right quantity, the right local delivery point, and no margin account.

The elevator has now promised to buy corn at a fixed price, so it carries the price risk. To offset it, the elevator sells two December corn futures (2 x 5,000 bushels). If December futures fall to $4.10 by November:

The elevator’s futures gain: $0.40 x 10,000 = $4,000, collected through daily variation margin.
It pays the farmer the agreed $4.30, which is now above the local market price, roughly the $4,000 it gained on futures.

The risk passed from the farmer to the elevator through a forward, and from the elevator to the futures market through a hedge. The farmer’s only remaining exposure is to the elevator: if it failed before November, the forward price would be worth only what could be recovered.

Who uses which

Corporations hedging currencies often use bank forwards, because they need exact amounts and dates and may not want to manage daily margin.
Farmers often sign forward contracts directly with a local grain elevator, which then hedges its own exposure in the futures market.
Funds and traders tend to use futures, because they are liquid, transparent, and easy to close.
Large institutions use both, depending on the market. Many OTC derivatives are now centrally cleared and margined, which makes them behave more like futures.

The broader set of participants is covered in who trades futures.

What can go wrong

With forwards: your counterparty may fail; exiting early can be expensive because only one dealer quotes you; prices are not public, so it is harder to know if you got a fair rate.
With futures: daily margin calls can drain cash even when a hedge is working; the fixed contract size and date may not match your exposure; and leverage makes it easy to take on far more exposure than intended.
With both: a hedge removes upside as well as downside. If the price moves your way, the gain on your business is offset by a loss on the hedge.

The short version

Forwards are private, flexible contracts settled at the end, with credit risk on the other party. Futures are standardised exchange contracts with a clearing house in the middle and daily cash settlement. The economics are nearly the same; the differences are fit, liquidity, credit risk, and the timing of cash. Choosing between them is mostly a question of which of those risks you would rather manage.