OPTIONS
A contract that gives the buyer the right, but not the
FORWARDS
A customized contract between two parties to buy or
sell an asset at a future date at a price agreed upon
today.
OTC (over-the-counter) contracts that are privately
negotiated between parties.
No margin is required to enter into a forward contract.
The parties bear the counterparty risk of the other party.
Settlement occurs on the maturity date of the contract.
FUTURES
A standardized contract between two parties to buy or
sell an asset at a future date at a price agreed upon
today.
Traded on an exchange.
Margin is required to enter into a futures contract.
The exchange acts as the counterparty to both
parties, eliminating counterparty risk.
Settlement occurs daily based on the prevailing
market price.
obligation, to buy or sell an underlying asset at a
predetermined price at or before a specified date.
OTC and exchange-traded options are available.
A premium is paid by the buyer to the seller to enter into an
options contract.
The buyer has limited downside risk, and the seller has
limited upside potential.
Settlement can occur at expiry or through exercise before
expiry.
DERIVATIVE
INSTRUMENTS
SWAPS
A contract between two parties to exchange cash flows
based on different variables such as interest rates or
currencies.
OTC contracts that are privately negotiated between
parties.
No upfront payment is required to enter into a swap.
The parties bear the counterparty risk of the other party.
Settlement occurs periodically throughout the life of the
contract.
DIFFERENCES
Forwards and futures are contracts to buy or sell an
asset, while options and swaps are contracts to
exchange cash flows.
Forwards are customized contracts, while futures are
standardized contracts.
Forwards are traded OTC, while futures are traded on
an exchange.
Options give the buyer the right, but not the
obligation, to buy or sell an underlying asset, while
forwards, futures, and swaps are obligations.
Swaps exchange cash flows based on different
variables, while forwards, futures, and options
exchange cash flows based on the price of an
underlying asset.
SIMILARITIES
All four types of derivative instruments can be used for
hedging, speculation, and arbitrage.
All four types of derivative instruments involve a
contract between two parties.
Forwards, futures, and options involve the transfer of
price risk, while swaps involve the exchange of cash
flows based on different variables.
All four types of derivative instruments require the
parties to agree on a price or cash flow exchange rate
at the time of contract formation.