Forward, Futures, and Options are trading contracts or agreements that investors make, to buy or sell an asset at a specified price and date in the future. The trading contracts are designed to manage risks and take advantage of the market’s price variations.
In this article, we will explore what forward, futures, and options contracts mean in crypto, and what makes them different from each other. Having a good understanding of these commonly used contracts for trading cryptocurrencies is extremely important for staying away from making uninformed decisions. So, let’s get started.
What Is A Forward Contract?
Forward contracts are contracts that are privately made between a buyer and seller for trading a cryptocurrency asset on a futures date and agreed-up price. As the contract is private, it is not sold on exchanges, giving both parties involved in trade enough flexibility on the terms and conditions. Forward contracts are settled once at the end of the contract.
Forward contracts are one of the commonly used trading contracts across markets including stock, commodity, and even cryptocurrencies. Forward contracts let you speculate on the future price of the asset, and make a contract to buy it at a future price. This means that if two parties agree to sell Litecoin (for example) at $110, they are required to abide by the contract and make the trade on the specified date even if the price goes above or below the agreed-upon price.
As futures contracts are made privately, it requires immense trust between the parties involved, to agree. There is a high chance of one of the parties backing down on the contract. So, forward contracts are usually not accessible to regular retail investors.
Key Characteristics
- Flexible terms and conditions
- Traded on OTC (over-the-counter) markets privately
- Less regulation and comes with counterparty risks
- Settled at the end of the contract term
What Is A Futures Contract?
A futures contract is also involved with two parties agreeing to sell an underlying asset at an agreed price on a future date. Unlike Forward contracts, futures are sold on exchanges. So, futures contracts are generally shown to have better liquidity and uniformity. This means that the investors can enter and exit by selling off their futures contracts anytime they please.
The terms of futures contracts are highly standardized and there is less room for customization. However, it provides a great opportunity for speculators to take advantage of the price movements in the market. They enter into the market for a short term and close the contract before maturity, to cash out their profits. As futures are traded on exchanges with intermediaries, there is less chance of counterparty risks.
Key Characteristics
- Less flexibility in the terms of the contract
- Traded on centralized exchanges
- Have better liquidity and less counterparty risks
- Have strict regulations by entities such as the Commodity Futures Trading Commission (CFTC)
What Are The Options?
Options is another trading contract that enables traders to buy or sell the underlying asset at a specified price on a future date. Unlike futures and forward contracts, in options, the investors are not obligated to buy or sell the asset at the specified price at any time before the contract’s expiry. This means that the participants may choose not to exercise their options.
Crypto options are offered through centralized exchanges such as Bit.com, Bubit, Derbit, or OKX. So, they also have a higher liquidity than a forward contract. There are two types of options: Call and Put options. In a Call option, the investor has the right to buy the underlying asset. Whereas the Put option gives investors the right to sell the asset.
Key Characteristics
- Though investors have the right, they are not obligated to by or sell the underlying asset at a predetermined price and date.
- They are traded on derivative exchanges and centralized exchanges
- Have better liquidity than forward contracts
Forward Contract Vs Futures Contract Vs Options
Let’s further explore the differences between these financial instruments with the help of the below comparison table:
| Aspect | Forward Contract | Futures Contract | Options |
| Flexibility | Highly flexible terms and conditions | More rigid terms and conditions | More rigid terms and conditions |
| Traded On | Over the counter | Exchanges | Exchanges |
| Counterparty Risks | Higher | Lower | Lower |
| Liquidity | Less liquid in comparison | Better liquidity | Better liquidity |
| Upfront Costs | None upfront | The initial margin should be paid | Pay a premium upfront |
| Counterparty Risks | High | Very low | Very low |
Forward, Futures, and Options are helpful financial instruments commonly used for mitigating risks and taking profits from the price movements. They each have their characteristics and defining features.
Final Thoughts
Forward, futures, and options are financial instruments that allow investors to buy the underlying asset on a specified date at a predetermined price. Forward options are more flexible as it is sold privately over the counter. Futures are more regulated and have rigid terms and conditions, but they are sold on standardized exchanges giving better liquidity. Whereas, Options give investors the right to buy the underlying asset at a specified date and time but it is not an obligation. Knowing these key differences can help you navigate the cryptocurrency market.
