fwd contract often has negative value, briefly

An option “paper” is a right but not an obligation, so its holder has no obligation, so this paper is always worth a non-negative value.

if the option holder forgets it, she could get automatically exercised or receive the cash-settlement income. No one would go after her.

In contrast, an obligation requires you to fulfill your duty.

A fwd contract to buy some asset (say oil) is an obligation, so the pre-maturity value can be negative or positive. Example – a contract to “buy oil at $3333” but now the price is below $50. Who wants this obligation? This paper is a liability not an asset, so its value is negative.

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fwd price@beach^desert – intuitive

Not that easy to develop an intuitive understanding…

Q2.46 [[Heard on the street]]. Suppose the 2 properties both sell for $1m today. What about delivery in x months? Suppose the beach generates an expected (almost-guaranteed) steady income (rental or dividend) of $200k over this period. Suppose there’s negligible inflation over this (possibly short) period.

Paradox: you may feel after x months, the beach would have a spot price around $1m or higher, since everyone knows it can generate income.
%%A: there’s no assurance about it. It could be much lower. I feel this is counter-intuitive. There might be war, or bad weather, or big change in supply/demand over x months. Our calculation here is based solely on the spot price now and the dividend rate, not on any speculation over price movements.

I guess the fair “indifferent” price both sides would accept is $800k, i.e. in x months, this amount would change hand.
– If seller asks $900k forward, then buyer would prefer spot delivery at $1m, since after paying $1m, she could receive $200k dividends over x months, effectively paying $800k.
– If buyer bids $750k forward, then seller would prefer spot delivery.

What would increase fwd price?
* borrowing interest Cost. For a bond, this is not the interest earned on the bond
* storage Cost

What would decrease fwd price?
* interest accrual Income
* dividend Income

eq-fwd contract – delivery price K

Eg: me buying Blk 155 flat. In Oct we agreed on $615 delivery price. Cash-On-Delivery on the delivery date in Feb. “Logistics”… No exposure no mkt risk.

Eg from [[hull]] P104. $40.50 delivery price means $40.50 cash to change hand on the delivery date.

Simple rule — No cash flow on execution date – different from most other trades. Simple difference yet very confusing to some.

Simple rule — To understanding the “delay”, we can imagine sky high interest, carry and inflation rates.

Simple rule – Cash-On-Delivery

I feel the delayed cashflow is at the heart of the (simple) arb and math. If we aren’t absolutely clear about this delay, big messy confusions …

EE context — yes deliver price is an important factor to PnL, risk mgmt etc
QQ context – delivery price is the price quoted and negotiated

Q: In each fwd contract, are there 2 prices?
QQ context – 1 only
EE context – 2 indeed. Similar to simply buying then holding IBM shares. Both prices are relevant in the EE context —
• K is the negotiated “execution” price, implicitly written into the fwd contract
• there’s a live market price for the same fwd contract.

fwd px ^ px@off-market eq-fwd

fwd price ^ price of an existing eq-fwd position. Simple rule to remember —
QQ) not $0 — fwd price is well above $0. Usually close to the current price of the asset.
EE) nearly $0 — current “MTM value” (i.e. PnL) of an existing fwd contract is usually close to +-$0. In fact, at creation the contract has $0 value. This well-known statement assumes both parties negotiated the price based on arb pricing.

Q: With IBM fwd/futures contracts, is there something 2D like the IBM vol surface?

2 contexts, confusing to me (but not to everyone else since no one points them out) —

EE) After a fwd is sold, the contract has a delivery price “K” and also a fluctuating PnL/mark-to-market valuation “f” [1]. Like a stock position (how about a IRS?) the PnL can be positive/negative. At end of day 31/10/2015, the trading venue won’t report on the MTM prices of an “existing” contract (too many), but the 2 counter-parties would, for daily PnL report and VaR.

If I’m a large dealer, I may be long/short a lot of IBM forward contracts with various strikes and tenors — yes a 2D matrix…

[1] notation from P 109 [[hull]], also denoted F_t.

QQ) When a dealer quotes a price on an IBM forward contract for a given maturity, there’s a single price – the proposed delivery price. Trading venues publish these live quotes. Immediately after the proposed price is executed, the MTM value = $0, always

The “single” price quoted is in stark contrast to option market, where a dealer quotes on a 2D matrix of IBM options. Therefore the 2D matrix is more intrinsic (and well-documented) in option pricing than in fwd contract pricing.


In most contexts in my blog, “fwd price” refers to the QQ case. However, in PCP the fwd contract is the EE type, i.e. an existing fwd contract.

In the QQ context, the mid-quote is the fwd price.

Mathematically the QQ case fwd price is a function of spot price, interest rate and tenor. There’s a simple formula.

There’s also a simple formula defining the MTM valuation in EE context. Its formula is related to the QQ fwd quote formula.

Both pricing formulas derived from arbitrage/replication analysis.


EE is about existing fwd contracts. QQ is about current live quotes.

At valuation time (typically today), we can observe on the live market a ” fwd price”. Both prices evolve with time, and both follow underlier’s price S_t. Therefore, both prices are bivariate functions of (t,S). In fact, we can write down both functions —

QQ: F_t = S_t / Z_t ….. (“Logistics”) where Z_t is the discount factor i.e. the T-maturity discount bond’s price observed@ t
EE: p@f = S_t – K*Z_t

( Here I use p@f to mean price of a fwd contract. In literature, people use F to denote either of them!)

To get an intuitive feel for the formulas, we must become very familiar with fwd contract, since fwd price is defined based on it.

Fwd price is a number, like 102% of current underlier price. There exists only one fair fwd price. Even under other numeraires or other probability measures, we will never derive a different number.

In a quiz, Z0 or S0 may not be given to you, but in reality, these are the current, observed market prices. Even with these values unknown, F_t = S_t / Z_t formula still holds.

Black’s model – uses fwd price as underlie, or as a proxy of the real underlier (futures price)

Vanilla call’s hockey stick diagram has a fwd contract’s payoff curve as an asymptote. But this “fwd contract’s payoff curve” is not the same thing as current p@f, which is a single number.

hockey stick – asymptote

(See also post on fwd price ^ PnL/MTM of a fwd position.)

Assume K = 100. As we get very very close to maturity, the “now-if” graph descends very very close to the linear hockey stick, i.e. the “range of (terminal) possibilities” graph.

10 years before maturity, the “range of (terminal) possibilities” graph is still the same hockey stick turning at 100, but the now-if graph is quite a bit higher than the hockey stick. The real asymptote at this time is the (off-market) fwd contract’s now-if graph. This is a straight line crossing X-axis at K * exp(-rT). See http://bigblog.tanbin.com/2013/11/fwd-contract-price-key-points.html

In other words, at time 0, call value >= S – K*exp(-rT)

As maturity nears, not only the now-if smooth curve but also the asymptote both descend to the kinked “terminal” hockey stick.

eq-forward – basic questions to internalize

See also post on equity forward. Better become very very comfortable answering these questions. They should be in your blood:)

Q: daily mark to market of an existing position, on some intermediate date “t” before maturity.

Q: market risk of an existing long position?
A: similar to a simple long spot position. When underlier appreciates, we have a positive  PnL. “Logistics”.

Q: delta of  such an existing fwd contract?

There are many relationships  among many variables –

K, T — part of the contract specification
Z0, S0, — observable today
F0 — defined in the EE context as the MTM value of a new position. Almost always $0
ZT := 1.0, STFT := ST – K
Zt, St, Ft,  — where t is an intermediate time between now and T. Since t is in the future, these values are unknown as of today.

An interviewer could ask you about the relationship among any 3 variables, or the relationship among any 4 variables.

Warning — I use F0 to denote today’s price of an off-mkt fwd contract with K and T. Some people use F0 to denote the fwd price of the stock S.

PCP with dividend – intuitively

See also posts on PCP.
See also post on replicating fwd contract.

I feel PCP is the most intuitive, fundamental and useful “rule of thumb” in option pricing. Dividend makes things a tiny bit less straightforward.

C, P := call and put prices today
F := forward contract price today, on the same strike. Note this is NOT the fwd price of the stock.

We assume bid/ask spread is 0.

    C = P + F

The above formula isn’t affected by dividend — see the very first question of our final exam. It depends only on replication and arbitrage. Replication is based on portfolio of traded securities. (Temperature – non-tradable.) But a dividend-paying stock is technically non-tradable!

* One strategy – replicate with European call, European put and fwd contract. All tradable.

* One strategy – replicate with European call, European put, bond and dividend-paying stock, but no fwd contract. Using reinvestment and adjusting the initial number of shares, replication can still work. No need to worry about the notion that the stock is “non-tradable”.

Hockey stick, i.e. range-of-possibility graphs of expiration scenarios? Not very simple.

What if I must express F in terms of S and K*exp(-rT)? (where S := stock price any time before maturity.)

  F = S – D – K*exp(-rT) … where D := present value of the dividend stream.

predicted future px USUALLY exceeds current px – again

This is a pretty important concept …

Extreme example – Suppose home price is believed to be unpredictable or unstable for the next 3 months[1], and short term rental is impossible, and there are many equivalent houses on sale. You just bought one of these equivalent houses but need it in 3 months and you would have all the cash by then. Do you prefer to “settle” (i.e. pay cash and get key) now (A) or (B) in 3 months? You prefer B because A means you must start paying mortgage interest 3-month earlier.

Now suppose seller exploits your preference for B, and asks $1 more to do a fwd deal (B) instead of a spot deal (A), you would be wise to still prefer B because interest amount is likely to be thousands.

So $1 is too cheap. But what’s a fair price for the fwd deal? I think it’s exactly the spot price plus the mtg interest amount. For most securities, fwd price [2] is Higher than spot. (A few assets are exceptions and therefore important[3].) First suppose fwd price == spot price as of today, and ignore the positive/negative signs below —

* if interest_1 < rent_3, then seller gains. Some competing seller would sacrifice a bit of gain to sell at a lower fwd price. Fwd price is then driven down below spot price. This is the high-coupon case.
* if interest_1 > rent_3, then seller loses. She would simply reject the proposed trade. She would have to charge a Higher fwd price to compensate for her loss. This is the usual case, where rent_3 is $0 and there’s no repo or rent market for this asset.

I feel the fair theoretical fwd price is not affected by implied volatility, or by any kind of trend. A trend can continue or reverse. I feel the calculation of fwd price is based on assumption of constant asset price or random movement for the next x months.

[1] I think in most cases of fair pricing we assume the asset’s price has no up/down trend.
[2] If the spot contract doesn’t have a pair of start/end dates, i.e. a straightforward “cash-on-delivery” instrument, then I think in many cases “fwd price” means ” delayed settlement”.

[3] Their fwd price is Lower —
– High-coupon bonds such as treasury
– High-dividend stocks
– many currency pairs

Why the premium vs discount? There’s arbitrage mathematics at play. For most products, a fwd seller could 1) borrow cash to 2) buy the underlier today, 3) lend it out for the fwd term (say 90 days), and 4) deliver it on the fwd start date as promised. All deals are executed simultaneously today, so all prices fixed together, and a profit if any is locked in.

replicate eq-fwd contract, assuming a single dividend

See also
http://www.matthiasthul.com/joomla/attachments/article/121/ForwardReplication.pdf

Note replication portfolio is always purchased as a bundle, sometime (time t) before expiry (denoted time T).

First, let’s review how to replicate a forward contract in the absence of dividends. The replication portfolio is {long 1 share, short K discount bonds}. To verify, at T the portfolio payout is exactly like long forward. By arbitrage argument, any time before expiry the portfolio value must at all times equal the fwd contract’s price. I will spare you the math formula, since the real key behind the math is the replication and arbitrage.

Now, suppose there’s a percentage dividend D paid out at time Td before T. In this case, let’s assume the dividend rate D is announced in advance. To reduce the abstractness, let’s assume D=2%, K=$100, the stock is IBM. We are going to reinvest the dividend, not use it to offset the purchase price $100. (This strategy helps us price options on IBM.)

The initial replication portfolio now adjusts to –{ long 0.98 IBM, short 100 discount bonds}. At T, the portfolio is exactly like long 1 forward contract. Please verify!

(In practice, dividends are declared as fixed amount like $0.033 per share whatever the stock price, but presumably an analyst could forecast 2%.)

In simple quant models, there’s a further simplification i.e. continuous dividend yield q (like 2% annually). Therefore reinvesting over a period A (like 1Y), 1 share becomes exp(qA) shares, like exp(0.02*1) = 1.0202 shares.

Q: delta of such a fwd contract’s pre-maturity value? Math is simple given a good grip on fwd contract replication.
A: rep portfolio is { +1 S*exp(-qT),     -K bonds }.
A: key concept — the number of shares (not share price) in the portfolio “multiplies” (like rabbits)  at a continuous compound rate of q. Think of q = 0.02.
A: In other words

   F0 = S0*exp(-qT) – K*Z0

Differentiating wrt S0, delta = exp(-qT), which degenerates to 1 when q=0.

##basic steps in vanilla IRS valuation, again

* First build a yield curve using all available live rates. This “family photo” alone should be enough to evaluate any IRS
* Then write down all (eg 20) reset dates aka fixing date.
* Take first reset date and use the yield curve to infer the forward 3M Libor rate for that date.
* Find the difference between that fwd Libor rate and the contractual fixed rate (negotiated on this IRS contract). Could be +/-
* Compute the net cashflow to occur on that fixing/reset date.
* Discount that cashflow to PV. The discounting curve could be OIS or Libor based.
* Write down that amount.

Repeat for the next reset date, until we have an amount for each reset date. Notice all 20 numbers are inferred from the same “family photo”. Tomorrow under a new family photo, we will recalc/reval all 20 numbers.

Add up the 20 amounts to get the net PV in that position. Since the initial value of the position is $0, this net value is also the PnL.

fwd disc factor, fwd rate … again

(See other posts in this blog. I think they offer simpler explanations.)

(Once we are clear on fwd disc factor, it’s easy to convert it to fwd rate.)

basic idea — discount an distant future income to tomorrow, rather than to today.

First we need to understand all the jargon around PV discounting which discounts to today…

Fwd discount factor is Discounting an income (or outflow) from a distant future date M (eg Nov) to a “nearer day” T [1] (eg Aug) is based on information available as of today “t” — a snapshot “family photo”. That discount factor could be .98. We write it as P(today, Aug, Nov) = 0.98. The fwd discount function P(t, T, M) can be interpreted as discounting $1 income from Nov (M) to Aug (T), given information available as of today (t). Something like P( Nov -} Aug | today), reversing the order of the 3 dates. As t moves forward, more info becomes available, so we adjust our expectation and estimate to a more realistic value of .80

The core math concept is very simple once you get used to it. $0.7 today grows to $1 in Aug, and $1.25 in Nov. These 2 numbers are implied/derived from today’s prices. These are the risk-neutral expectations of the “growth”. So $1.25 in Nov is worth $0.7 today, i.e.

  P(Nov -} today) = 0.7/1.25. Similarly
  P(Aug -} today) = 0.7/1

These are simple discount factors, Now fwd discounting is

  P( Nov -} Aug | today) = 1/1.25 = 0.8

The original notation is P(today, Aug, Nov) = 0.8.

Note the 0.80 value is not discounted to today, but discounted to next month i.e. Aug only. For PV calculation, we often need to apply discounting on top of the fwd discount factor.

fwd rate is like an interest rate. 0.8 would mean 25% fwd rate.

eq-fwd contract pricing – internalize

Even if not actively traded, the equity forward contract is fundamental to arbitrage pricing, risk-neutral pricing, and derivative pricing. We need to get very familiar with the math, which is not complicated but many people aren’t proficient.

At every turn on my option pricing learning journey, we encounter our friend the fwd contract. Its many simple properties are not always intuitive. (See P 110 [[Hull]])

* a fwd contract (like a call contract) has a contractual strike and a contractual maturity date.Upon maturity, the contract’s value is frozen and stops “floating”. The PnL gets realized and the 2 counter-parties settle.
* a fwd contract’s terminal value is stipulated (ST – K), positive or negative. This is a function of ST, i.e. terminal value of underlier. There’s even a “range of possibilities” graph, in the same spirit of the call/put’s hockey sticks.
* (like a call contract) an existing fwd contract’s pre-maturity MTM value reacts to 1) passage of time and 2) current underlier price. This is another curve but the horizontal axis is current underlier price not terminal underlier price. I call it a “now-if” graph, not a  “range of possibilities” graph. The curve depicts

    pre-maturity contract price denoted F(St, t) = St                    – K exp(-r (T-t)  ) ……… [1]
    pre-maturity contract price denoted F(St, t) = St exp(-q(T-t)) -K exp(-r(T-t)) .. [1b] continuous div

This formula [1b] is not some theorem but a direct result of the simplest replication. Major Assumption — a constant IR r.

Removing the assumption, we get a more general formula
              F(St, t) = St exp(-q(T-t)) – K Zt
where Zt is today’s price of a $1 notional zero-bond with maturity T.

Now I feel replication is at the heart of everything fwd. You could try but won’t get comfortable with the many essential results [2] unless you internalize the replication.

[2] PCP, fwd price, Black model, BS formula …

Notice [1] is a function of 2 independent variables (cf call).  When (T – now) becomes 0, this formula degenerates to (ST – K). In other words, as we approach maturity, the now-if graph morphs into the “range of possibilities” graph.

The now-if graph is a straight line at 45-degrees, crossing the x-axis at    K*exp(-r  (T-t)  )

Since Ft is a multivariate function of t and St , this thing has delta, theta —

delta = 1.0, just like the stock itself
theta = – r K exp(-r  (T-t)  ) …… negative!

(Assuming exp(-q(T-t)) = 0.98 and
To internalize [1b], recall that a “bundle” of something like 0.98 shares now (at time t) continuously generates dividend converting to additional shares, so the 0.98 shares grows exponentially to 1.0 share at T. So the bundle’s value grows from 0.98St to ST , while the bond holding grows from K*Zt to K. Bundle + bond replicates the fwd contract.

 —————Ft / St is usually (above or below) close to 0 when K is close to S.  For example if K = $100 and stock is trading $102, then the fwd contract would be cheap with a positive (or negative) value.
** most fwd contracts are constructed with very low initial value.
* note the exp() is applied on the K. When is it applied on the S? [1]
* compare 2 fwd contracts of different strikes?
* fwd contract’s value has delta = 1

[1] A few cases. ATMF options are struck at the fwd price.

IRS valuation, again

When I see “value of a swap” I first remind myself this is about the value of a series of cash flows, like the combined value of “out $19, in $13, out $2, in $5 …”. This value could be positive or negative. Next I ask myself “value of the cash flows to side 1 or 2”? [1]

A) First, you are always one of A) fixed-receiver or B) float-receiver. I feel for a beginner like me, better focus on one side. [[Hull]] example focuses on the fixed receiver. If IRS is important to your job, you will see both sides so many times and they will become quick and intuitive. From now on, Let’s focus on the fixed receiver.

B) The “position” on our book is valued as a series of cash flows including Inflow and outflow. The valuation calc basically
1) predict the size of each inflow and outflow at each future payment date [1]
2) discounts the net Inflow to PV like $81, -$12, -$25, $52..
3) add up the PV to a single dollar amount like $99

If total inflow PV is positive, then the position is like an asset (as of today). Devil is in the details. For now, step back from the gory details and notice the few important details —

Q: key question (per Kuznetsov) is how to estimate today the rate [1] to be announced in 3 months (by the BBA). It’s not fixed on sign-up but “floating” like the future temperature in Dublin 3 months in the future. How is it estimated?
A: basically use the IR numbers known today to back out (RN?) the 3×9 fwd rate “6M rate 3M forward”. I guess this is like the UIP (not the CIP) — treating the RN expected spot rate as the natural expected spot rate. See http://en.wikipedia.org/wiki/Forward_rate_agreement

Note the very first payment date is fixed, not some “unknown future temperature”. See [[Hull]].

Q: what kinda input data are needed to produce the soft market data which are needed for IRS valuation?
A: Lin Yu pointed out the key soft market data is the libor/swap curve, which often uses Libor, ED Futures , Swap rates from the market. But that’s a bit involved. For now, let’s look at the simple calc in [[Hull]]
A: Libor deposit rates. (A bit tricky!) If valuation-date is denoted T, and the payment dates are T+3M, T+9M .. then we need rate for a loan from T to T+3M.
** I’d say from Libor deposit rates T to T+…., we could estimate all the floating payment.
** note ED future rates are not used in this simple calc.

[1] A minor point — if the value of the cash flows nets to positive for one side, it must be negative for the opposite side.

upper bounds on vanilla call/put prices

Background — needed in many quant simple quizzes, or appetizers. There are lots of intuitions involved.

— The easy part — lower bounds —

call – $0 or the fwd contract’s price i.e. S_now – K*exp(-rT)
put – $0 or the short fwd i.e. K*exp(-rT) – S_now

— Now the upper bounds —

put ~ K*exp(-rT). Consider a super replicating {K bonds}.
call ~ S_now i.e. the current stock price itself. Consider a super replicating {1 share}. At expiration, the stock dominates the call, ditto before expiration.

forward contract — my invention in 1997

I once told an NUS classmate (Liu Ning?) that after market close a buyer and seller can agree to trade a stock. Over the weekend they agree on a price. Whether it’s higher or lower than the Monday opening price, they execute regardless. This is a forward contract !!

CFA covers 4 major derivatives, and forward is the basis of 3 of them —

– forward is basis of IRS
– forward is basis of futures.

FRA is the most important type of forward.

equity forward is the simplest forward, followed by bond forward.

FX fwd arbitrage – 4 b/a spreads to OVERCOME

Look at the parity between fwd/spot FX rates and the 2 interest rates (in the 2 currencies). Basic concept looks simple, but in the real market each rate is quoted in bid and ask. 8 individual numbers involved.

We pick 4 of them to evaluate ONE arbitrage strategy (fwd rate too high) and the other 4 to evaluate another arbitrate opportunity (fwd rate too low)

Across asset classes, most pricing theories assume 0 transaction cost and 0 bid/ask spread. In this case, the bid/ask spread is often the showstopper for the arbitrageur. Similar challenge exists for many option arbitrageurs.

I think [[complete guide to capital markets]] has one page illustrating this arbitrage.

PCP – how to internalize, using PnL

(PCP under continuous dividend model? See http://bigblog.tanbin.com/2013/11/equity-fwd-contract-pricing-internalize.html)

key PCP concept — the equivalence of values of 2 portfolios ANY time after you buy them, not just at expiration. However, the valuation (plotted against S) at any time before expiration is non-intuitive and hard to grapple.

Suppose A buys a long European call and B buys [a long European put + a futures]. All instruments were bought at a fair price, so PnL both start $0. (MV is irrelevant at this stage.) N days later, when market rates (spot, implied vol…) have moved a bit, we would expect both portfolios to show small but identical PnL[1]. Therefore, looking at PnL rather than MV, the cash component disappears from the equation, since cash will (almost) always have zero PnL.

Note MV is a poorly defined (non-intuitive) concept for futures and a lot of derivatives. See post on MktVal clarified.

Similar to the PnL view, the delta view involves only 3 positions — call/put/forward, not  the cash.

[1] exact PnL amount is hard to visualize as it involves BS.

(A: European options have no assignment before maturity.)

Now let’s look at MV or valuations. Valuations are more important in practice and relate to observed market prices. At t=0 portfolio MV are equal only if we started at t= -1 with an equal amount of seed capital. At t=0, MV becomes (assuming zero interest rate)

  Premium_c + $K cash = Premium_p + f

N days later, or at expiration, MV becomes

  MV_c + $K cash = MV_p + MV_f

Some people (like my boss Saurabh) say a long call + a short put == a forward [2], but I find it less intuitive. LHS is the difference between the 2 premiums, which could be 0 or negative.

Update – Now I agree C = P + F is the best way to remember it, once you recognize that you must get down to details with the fwd contract and build intimate knowledge thereof.

I guess the statement in [2] assumes a long position in the forward contract can become either an asset or liability any time before expiration. If I must translate [2] into English, i would say a long call combining a short put has identical PnL to a forward contract (assuming European options). Suppose both portfolios start with just the positions + no cash. At T=0, all 3 securities are bought at fair values, so Portfolio A has PnL=0, so does B. Based on the delta rule above, a 1 cent change in underlier would result in identical changes in the 2 portfolio’s valuations, so the 2 portfolios always have identical valuations, either positive or negative.

What if your short put gets assigned? Answer is hidden somewhere in this blog. If you indeed lose the short position, the delta rule will stop working.

Is PCP compromised by any of the “unrealistic/simplistic” assumptions of BS? No. PCP is model-independent.

Is PCP affected by the vol skew or the vol term structure ? I don’t think so.

forward contract^futures contract

a futures contract == a standardized forward contract guaranteed by an exchange, just as
a listed option == a standardized version of an OTC option

I feel we should first understand commodity forward contracts first. Commodity futures are the simplest and earliest form of futures. Forward contract is the foundation of futures; futures contracts form a foundation for IRS, swaption and other derivatives.

Note the fundamental entity (or tradable instrument) is the contract. A forward corn contract is nothing but a spot corn contract with a future delivery date. Note price is fixed at the transaction time, otherwise there’s no contract, no agreement, no obligation.

In mid 1997 i took short positions on copper futures market, agreeing to sell (for a future date) at relatively low delivery prices (say $121k) and lost badly when prices rose. I had to cover the short by entering a long position (say 131k). Counter party to every contract is always the Exchange. Effectively, i agreed with Exchange to sell to Exchange at 121k and buy at 131k for the same quantity of copper for the same delivery date. When I entered each position some sum was frozen in my margin account. Since my 2 positions cancelled out and $10k was permanently frozen (actually transferred out). Exchange or the broker allowed me to close my margin account.

This is a forward contract, but traded on the exchange.

http://thismatter.com/money/forex/fx_forwards.htm says

“FX futures are basically standardized forward contracts. Forwards are contracts that are individually negotiated and traded over the counter, whereas futures are standardized contracts trading on organized exchanges. Most forwards are used for hedging exchange risk and end in the actual delivery of the currency, whereas most positions in futures are closed out before the delivery date”

FX fwd outright^swap, rolling fwd, repo…briefly

There are 2 instruments in FX forward. Forward outright is among the simplest types of financial forward contracts. You actually exchange (like going through the money-changer exactly once) the 2 amounts on a future date. This instrument is not tradable.

(An alternative form of outright is NDF, common for Chinese RMB. Money-changer 0 times i.e. never. It’s a cash-settled derivative just like FRA or IRS.)

The more complex forward instrument is the FX swap (I don’t mean “currency swap”, which is basically IRS). Tradable on interbank market. Money-Changer 2 times, on Near date and Far date. To understand the Need for FX swap, we need to understand rolling forward….

FX swap is like a repo — 2 legs, 2 settlement dates.

Important jargon/concepts in FX forward
* near date, far date
* near leg (usually “spot leg”), forward leg

Most FX forward contracts have a timeline of 1 to 12 months from trade date. Same for FX options.