Forward and option differences

forward and option differences

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Futures are traded on an exchange whereas forwards are traded over-the-counter. Counterparty risk In any agreement between two parties, there is always a risk that one side will renege on the terms of the agreement.

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Participants may be unwilling or unable to follow through the transaction at the time of settlement. This risk is known as counterparty risk.

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In a futures contract, the exchange clearing house itself acts as the counterparty to both parties in the contract. To further reduce credit risk, all futures positions are marked-to-market daily, with margins required to be posted and maintained by all participants at all times.

All this forward and option differences ensures virtually zero counterparty risk in a futures trade. Forward contracts, on the other hand, do not have such mechanisms in place.

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Since forwards are only settled at the time of delivery, the profit or loss on a forward contract is only realized at the time of settlement, so the credit exposure can keep increasing. Hence, a loss resulting from a default is much greater for participants in a forward contract. Secondary Market The highly standardized nature of futures contracts makes it possible for them to be traded in a secondary market.

Updated Apr 6, Call Option vs. Forward Contract: An Overview Forward contracts and call options are different financial instruments that allow two parties to purchase or sell assets at specified prices on future dates. Forward contracts and call options can be used to hedge assets or speculate on the future prices of assets. A call option gives the buyer the right not the obligation to buy an asset at a set price on or before a set date.

The existence of an active secondary market means that if at anytime a participant in a futures contract wishes to transfer his obligation to another party, he can do so by selling it to another willing party in the futures market. In contrast, there is essentially no secondary market for forward contracts. More Articles.

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