NISM-Series-X-A: Investment Adviser (Level 1) · Understanding Derivatives

Forwards and Futures Contracts: Differences, Margin and Pricing

Updated 11 October 2026 · Fact-checked

A forward is a private, customised contract to buy or sell an asset at a fixed price on a future date. A futures contract is the standardised, exchange-traded version, with margins and daily mark-to-market. Fair price by cost of carry: F = S × (1 + r × t), or S × e^(r×t) if continuously compounded, adjusted for income.

Understand Forwards and Futures Contracts

A derivative gets its value from an underlying asset such as a share, index, currency or commodity. Forwards and futures are the simplest derivatives. Both fix today the price at which an asset will be bought or sold on a future date.

A forward contract is an over-the-counter (OTC) agreement between two parties. The terms are customised: asset, quantity, price and date. It is usually settled on the maturity date. Because there is no exchange or clearing corporation in between, there is counterparty risk: the other side may default. It is also illiquid, because you cannot easily exit before maturity.

A futures contract is a standardised forward traded on an exchange. The exchange fixes the lot size, expiry date and underlying. A clearing corporation becomes the counterparty to every trade (this is called novation). By doing so, and by collecting margin and settling gains and losses every day through mark-to-market (MTM), it greatly reduces counterparty (default) risk for participants. The risk is managed, not removed. In India, index derivatives are cash-settled on expiry. Stock derivatives currently settle physically on expiry, subject to SEBI rules. The settlement mode is set by SEBI and the exchanges, so it can change. A position closed before expiry is squared off, and the profit or loss is settled in cash at the difference between the entry and exit prices.

Pricing uses the cost of carry. If you buy the asset today and hold it until expiry, you pay a financing cost (interest) and maybe storage cost, and you may earn income (dividend). The futures price should equal the spot price plus the net cost of carry. If it does not, arbitrageurs buy the cheaper side and sell the dearer side until the gap closes.

This page defines basis as Spot − Futures and uses that convention throughout. When futures trade above spot, the market is in contango, and the basis is negative. When futures trade below spot, it is in backwardation, and the basis is positive. Backwardation often appears when the income or convenience yield from holding the asset is more than the financing cost. For a dividend-paying share, a futures price below spot is simply cost-of-carry pricing at work, not a market anomaly.

The long side gains when the price rises and the short side gains when it falls. The gain of one equals the loss of the other. Futures give leverage, because you put up only margin, not the full value. This magnifies both profit and loss.

Key formulas to remember

Cost of carry (continuous compounding): F = S × e^(r × t); S = spot price, r = annual risk-free rate, t = time to expiry in years. No income on the asset.
Cost of carry (simple or discrete form): F = S × (1 + r × t); Use this when the question gives a simple interest rate and says nothing about continuous compounding.
Cost of carry with known dividend: F = S × (1 + r × t) − D; D = dividend expected before expiry. Income reduces the futures price.
Cost of carry with storage cost: F = S × (1 + r × t) + storage cost; Storage and insurance add to the price for commodities.
Basis: Basis = Spot price − Futures price; Under this convention, contango (futures above spot) gives a negative basis and backwardation (futures below spot) gives a positive basis. Basis moves towards zero at expiry (convergence). Some texts define basis as futures minus spot, which reverses the signs, so follow the question's definition.
Daily MTM: MTM = (Today's settlement price − Previous settlement price) × Quantity; For a long position. A positive figure is a credit; for a short position the sign reverses.
Profit or loss on futures: Long: (Exit price − Entry price) × Quantity; Short: (Entry price − Exit price) × Quantity; Quantity = lot size × number of lots.

How to solve Forwards and Futures Contracts questions

Most questions on this topic are either conceptual (forward versus futures) or numerical (pricing, MTM, profit or loss). This method covers both.

1Identify what is asked: a definition, a feature comparison, a fair price, a margin or MTM amount, or a profit or loss.
2For concept questions, decide if the feature belongs to an OTC contract (customised, counterparty risk, no daily settlement) or an exchange contract (standardised, clearing corporation, margin, MTM).
3For pricing, list S, r, t, and any dividend or storage cost. Convert time to years, for example 3 months = 0.25.
4Pick the formula: simple form if the question gives no compounding hint, continuous form if it gives e^ or says continuously compounded. Subtract income, add storage cost.
5For MTM, find each day's change in settlement price, multiply by quantity, and apply the sign for long or short.
6For profit or loss, use exit minus entry for long and entry minus exit for short, then multiply by lot size and number of lots.
7Check the sign and magnitude: a long position gains when prices rise; fair futures price should be above spot when interest is positive and there is no income.
8Read all four options and eliminate those with a wrong sign or an unconverted time period.

Quickest way: Scan for the contract type and the sign

When to use it: Use this for MCQs where you have under a minute per question.

If the question mentions customised terms, OTC or default risk, think forward. If it mentions exchange, lot size, margin or daily settlement, think futures.
For pricing, estimate S × (1 + r × t) first. Remove any dividend. This usually leaves one option close to your estimate.
For profit or loss, ask who gains when the price moves. Long gains on a rise, short on a fall.
Multiply by the full quantity (lot size × lots) at the end, not before you decide the sign.

Common mistakes in Forwards and Futures Contracts

Saying a futures contract has no counterparty risk for the exchange to worry about, or that a forward has a clearing corporation.
Students mix the features of OTC and exchange-traded contracts.
Fix: Remember: forward = OTC, bilateral, counterparty risk. Futures = exchange, clearing corporation guarantees performance, margins and MTM manage risk.
Using months directly as t in the cost of carry formula.
Rushing and forgetting that the rate is annual.
Fix: Convert to years first: 3 months = 3 ÷ 12 = 0.25 years.
Adding the dividend to the futures price instead of subtracting it.
Students treat all carrying items as costs.
Fix: Income from the asset (dividend) lowers the cost of holding, so it reduces the futures price. Storage cost raises it.
Getting the sign wrong in MTM for a short position.
Students apply the long formula to every position.
Fix: For a short, a price fall is a credit and a price rise is a debit. Reverse the sign of the long MTM.
Forgetting to multiply by the lot size or number of lots.
The per-unit price change looks like the final answer.
Fix: Always compute quantity = lot size × lots and multiply last.
Believing margin is the full price or a fee that is lost.
Margin is confused with premium or with the contract value.
Fix: Margin is a performance deposit that stays yours, adjusted by daily gains and losses. It is only a part of the contract value.

Worked examples

Example 1

A stock trades at ₹500 in the spot market. The risk-free rate is 8% per annum (simple, for cost of carry). No dividend is expected. What is the fair price of a 3-month futures contract?

Show the solution

S = ₹500, r = 8% = 0.08, t = 3 ÷ 12 = 0.25 years.
F = S × (1 + r × t) = 500 × (1 + 0.08 × 0.25).
0.08 × 0.25 = 0.02, so 1 + 0.02 = 1.02.
F = 500 × 1.02 = ₹510.

Answer: ₹510

Example 2

You buy 2 lots of a stock future, with a lot size of 500 shares, at ₹200. The settlement price on day 1 is ₹204 and on day 2 is ₹201. What is the MTM on day 1, on day 2, and your total gain at the end of day 2?

Show the solution

Quantity = 500 × 2 = 1,000 shares. You are long.
Day 1 MTM = (204 − 200) × 1,000 = ₹4,000 credit.
Day 2 MTM = (201 − 204) × 1,000 = −₹3,000, a debit of ₹3,000.
Total = 4,000 − 3,000 = ₹1,000, which also equals (201 − 200) × 1,000.

Answer: Day 1: ₹4,000 gain; Day 2: ₹3,000 loss; net gain ₹1,000

Exam tips

Learn the forward versus futures comparison as a list: customised or standard, OTC or exchange, counterparty risk or guaranteed, no MTM or daily MTM, illiquid or liquid.
In pricing questions, check whether the question gives a dividend or storage cost before you pick the formula.
Wrong answers cost marks, and a 2-mark caselet question costs twice as much as a 1-mark one, so avoid guessing blindly on long calculations. Eliminate options first.
Expect caselet questions that combine futures with hedging. A long hedger fears a price rise; a short hedger fears a fall.
Always write down units: per share, per lot, and total.

Practice questions from Understanding Derivatives

Forwards and Futures Contracts in other exams

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

Forwards and Futures Contracts: frequently asked questions

What is the difference between forwards and futures?

A forward is a customised OTC contract settled at maturity with counterparty risk. A futures contract is standardised, traded on an exchange, guaranteed by the clearing corporation and settled daily through mark-to-market. Futures are more liquid; forwards are more flexible.

What is the cost of carry formula for futures pricing?

The basic form is F = S × (1 + r × t), where S is spot, r is the annual rate and t is time in years. With continuous compounding it is F = S × e^(r×t). Subtract expected dividends and add storage costs where given.

What is mark-to-market in futures?

It is the daily settlement of gains and losses. Each day your position is valued at the settlement price and the difference from the previous day is credited or debited to your account. This stops losses from building up unpaid.

How is margin different from the futures price?

Margin is a deposit that covers possible losses, and it is only a fraction of the contract value. The futures price is the price at which the underlying will be bought or sold. Margin is not a cost and is adjusted by daily MTM.