NISM-Series-VIII: Equity Derivatives · Basics of Derivatives

Types of Derivative Contracts: Forwards, Futures, Options, Swaps

Updated 11 October 2026 · Fact-checked

The four basic derivative types are forwards, futures, options and swaps. Forwards and futures oblige both sides to trade at a fixed price on a future date. Options give the buyer a right, not an obligation. Swaps exchange cash flows over time. To answer questions, ask who has the obligation, where it trades, and what is exchanged.

Understand Types of Derivative Contracts

A derivative is a contract whose value depends on an underlying asset, such as a share, an index, a currency, a commodity or an interest rate. You do not own the asset. You own a contract linked to its price.

A forward contract is a private agreement between two parties to buy or sell an asset at a fixed price on a future date. It is traded over the counter (OTC), so terms are customised. Because it is private, it carries counterparty risk: the other side may default. It is also hard to exit before maturity.

A futures contract is a standardised forward traded on an exchange. Contract size, expiry and tick size are fixed by the exchange. A clearing corporation stands between buyers and sellers, which removes most counterparty risk. Positions are marked to market daily and margins are collected.

An option gives the buyer the right, but not the obligation, to buy (call) or sell (put) the underlying at a fixed strike price. The buyer pays a premium for this right. The seller (writer) receives the premium and has the obligation if the buyer exercises. So the buyer's loss is limited to the premium, while the seller's risk can be large.

A swap is an agreement to exchange cash flows over a period, based on a notional amount. A common example is an interest rate swap, where one party pays fixed and the other pays floating. Swaps are mostly OTC. Currency swaps exchange cash flows in two currencies.

Key formulas to remember

Forward and futures obligation: Both buyer and seller are obligated to perform at expiry; Neither side has a choice. Payoff can be a gain or loss for both.
Option buyer: Right without obligation; pays premium; maximum loss = premium; Applies to both call buyers and put buyers.
Option seller (writer): Obligation if exercised; receives premium; maximum gain = premium; Loss can be very large for a call writer and large for a put writer.
Call vs put: Call = right to buy; Put = right to sell; Both are at the strike price, on or by expiry depending on option style.
Standardised vs customised: Futures, options on exchange = standardised; forwards, swaps = mostly OTC and customised; Exchange-traded contracts are guaranteed by the clearing corporation.
Swap: Exchange of cash flows on a notional amount; The notional principal is usually not exchanged in an interest rate swap.

How to solve Types of Derivative Contracts questions

Use this method for any question that asks you to identify or compare derivative types.

1Read the question and mark the key clue: private or exchange, obligation or right, premium, or exchange of cash flows.
2If a premium is paid for a right, the contract is an option. Decide call or put from the direction (buy or sell).
3If both parties are obligated and the contract is customised and private, it is a forward.
4If both are obligated but the contract is standardised, exchange-traded and marked to market, it is a futures contract.
5If periodic cash flows are exchanged on a notional amount, it is a swap.
6For risk questions, check who bears counterparty risk: OTC contracts carry it, exchange-traded ones are guaranteed by the clearing corporation.
7Eliminate options that misstate the obligation, such as saying an option buyer must perform.
8Pick the option that matches every clue, not just one.

Quickest way: Three-clue test

When to use it: Use it when the question gives a short description and four contract names or features.

Clue 1: Is a premium paid? Yes means option.
Clue 2: Is it traded on an exchange with standard terms? Yes means futures (or exchange-traded option). No means forward or swap.
Clue 3: Are cash flows swapped over time? Yes means swap.
Whatever remains after these three clues is your answer.

Common mistakes in Types of Derivative Contracts

Saying the option buyer is obligated to buy or sell.
Students mix the buyer's position with the seller's.
Fix: Remember: the buyer holds the right and pays the premium. Only the seller carries the obligation.
Treating futures and forwards as identical.
Both fix a price for a future date, so they look alike.
Fix: List the differences: futures are exchange-traded, standardised, marked to market and guaranteed by the clearing corporation. Forwards are OTC, customised and carry counterparty risk.
Believing a futures buyer pays a premium.
Students confuse margin with premium.
Fix: Margin is a security deposit and is not the price of the contract. Premium is paid only for options and is not refunded.
Thinking an option seller has limited loss.
Students apply the buyer's limited-loss rule to both sides.
Fix: Limited loss applies to the buyer only. The writer's gain is capped at the premium but the loss can be large.
Assuming swaps are traded on the stock exchange like futures.
Swaps are listed with other derivatives in the syllabus.
Fix: Swaps are generally privately negotiated OTC contracts. Link them with customisation and counterparty risk.

Worked examples

Example 1

Which of the following best describes an options contract? (A) Both parties must buy and sell at a fixed price on expiry (B) The buyer has the right but not the obligation to buy or sell at a fixed price (C) Parties exchange periodic interest payments on a notional amount (D) A private agreement with no standard terms and no premium

Show the solution

Look for the clue: right without obligation.
Option A says both parties must perform. That describes a forward or futures contract.
Option C describes a swap.
Option D describes a forward contract.
Option B states the buyer's right and no obligation, which defines an option.

Answer: B

Example 2

Two companies agree privately to exchange fixed-rate interest payments for floating-rate payments every six months on a notional amount of ₹50,00,00,000. What type of derivative is this, and does it carry counterparty risk?

Show the solution

The clue is periodic exchange of cash flows on a notional amount.
That identifies a swap, specifically an interest rate swap.
The agreement is private, so it is OTC.
No clearing corporation guarantees OTC contracts, so each party faces the risk that the other may default.

Answer: It is an interest rate swap, and it carries counterparty risk because it is privately negotiated.

Exam tips

Expect direct questions that give a description and ask you to name the contract. Match the single strongest clue first.
Watch for statements that swap the buyer and seller roles in options. Check who pays the premium and who has the obligation.
Questions on differences between forwards and futures usually test standardisation, exchange trading, margin and counterparty risk.
Negative marking applies in this paper at 25% of the marks for a question, so do not guess when two options both seem to fit. Re-read for the clue that separates them.

Practice questions from Basics of Derivatives

Types of Derivative Contracts in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Types of Derivative Contracts: frequently asked questions

What is the difference between forwards and futures?

A forward is a private, customised OTC contract with counterparty risk. A futures contract is standardised, traded on an exchange and guaranteed by the clearing corporation. Futures are also marked to market daily, with margins collected.

What is the difference between futures and options?

In futures, both buyer and seller are obligated to perform at expiry. In options, only the seller is obligated, while the buyer has a right and pays a premium. A futures buyer can lose or gain without limit, while an option buyer's loss is limited to the premium.

What are the four main types of derivatives?

They are forwards, futures, options and swaps. Forwards and swaps are mostly OTC. Futures and many options are traded on exchanges.

Do futures traders pay a premium?

No. They deposit margin, which acts as security against losses. Premium is paid only by option buyers to option sellers.