NISM-Series-XXI-A: Portfolio Management Services (PMS) Distributors · 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 futures price by cost of carry: F = S × (1 + r)^t, or S × e^((r − q)t) with continuous compounding and income yield q.

Understand Forwards and Futures Contracts

A derivative is a contract whose value depends on 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 you will buy or sell later.

A forward contract is an over-the-counter (OTC) agreement between two parties. You can customise the asset, quantity, price and date. There is no exchange in between, so each side faces counterparty risk: the other party may default. It is usually settled on the expiry date, and it is not very liquid because exiting needs the other party's consent.

A futures contract is a standardised forward traded on an exchange. The exchange fixes the lot size, expiry date and tick size. The clearing corporation becomes the counterparty to every trade, which removes counterparty risk. To protect the system, it collects margins and settles gains and losses every day.

Margins work like a good-faith deposit. Initial margin is paid when you open a position. Mark-to-market (MTM) means your position is revalued each day at the settlement price, and the gain or loss is credited or debited to your account the same day. If your balance falls below the maintenance margin, you get a margin call and must top up. Both buyer (long) and seller (short) pay margin, because both can lose.

Pricing uses cost of carry. Buying the asset today and holding it until expiry costs interest (financing) and storage, and may earn income such as dividends. So futures price = spot price + cost of carry. If the futures price is far from this fair value, arbitrageurs buy the cheaper side and sell the dearer side, pushing prices back. In India, index derivatives are cash-settled; stock derivatives are physically settled as per current SEBI and exchange rules. Always check the current rules for the contract in question.

Key formulas to remember

Cost of carry (simple, no income): F = S × (1 + r × t); S = spot price, r = annual interest rate, t = time in years (days ÷ 365). Used when the question says simple interest.
Cost of carry (annual compounding): F = S × (1 + r)^t; Use when the question gives annual compounding.
Cost of carry (continuous): F = S × e^((r − q) × t); q = dividend yield or income yield. Income on the asset lowers the futures price.
Cost of carry with known dividend: F = S × (1 + r × t) − PV or value of dividends; Subtract expected dividends received before expiry (compounded to expiry if asked).
Basis: Basis = Spot price − Futures price; With this convention, basis is normally negative when futures trade above spot (contango). It moves towards zero as expiry nears and is zero at expiry (convergence). The opposite convention is Basis = Futures price − Spot price, which is normally positive in contango. Read the question to see which one it uses.
Daily MTM: MTM = (Today's settlement price − Previous settlement price) × lot size × number of lots; For a long position. A short position has the opposite sign. On day one, use the entry price as the reference.
Contract value: Contract value = Futures price × lot size; Margin is a percentage of this value.

How to solve Forwards and Futures Contracts questions

Most questions on this topic are either a definition or difference question, or a small calculation on pricing or MTM. Use this sequence.

1Read the question and decide the type: feature or difference, margin or MTM, or fair price.
2For a feature question, check the key word: OTC or exchange-traded, customised or standardised, counterparty risk or clearing corporation, daily or only at expiry settlement.
3For a pricing question, list S, r, t and any dividend. Convert days into years using days ÷ 365.
4Match the formula to the wording: simple interest, annual compounding or continuous compounding. Subtract income earned on the asset.
5For an MTM question, compute the price change from the previous reference price. Multiply by lot size and number of lots.
6Fix the sign: a long position gains when price rises, a short position gains when price falls.
7Compare your result with the options. If the answer is only close to an option, recheck time conversion and rounding.
8 Eliminate options that break basic logic, such as futures price below cost of carry fair value when the asset pays no income.

Quickest way: Four-keyword filter

When to use it: Use for theory and difference questions where you have under a minute.

Forward = OTC, customised, counterparty risk, settled at maturity, low liquidity.
Futures = exchange-traded, standardised, clearing corporation guarantee, margin, daily MTM.
Pricing = spot plus carry. Interest raises the price, dividends lower it.
MTM = price change × lot size, with the sign by long or short.

Common mistakes in Forwards and Futures Contracts

Saying forwards have daily mark-to-market settlement.
Students blur the two contracts because both fix a future price.
Fix: Link daily MTM and margins only to futures. Forwards are normally settled once, at maturity.
Believing the buyer alone pays margin.
Margin sounds like a purchase deposit.
Fix: Both long and short positions can lose, so both pay margin to the clearing corporation.
Using days as years in the cost of carry formula.
Rushing and skipping the unit conversion.
Fix: Always write t = days ÷ 365 before putting numbers in the formula.
Adding dividends to the futures price.
Students treat every carry item as a cost.
Fix: Interest and storage are costs and add to price. Dividends are income and reduce the fair futures price.
Getting the sign wrong on MTM for a short position.
Students compute the change and forget which side they are on.
Fix: Short position profit = previous price − current price. Say it aloud as the opposite of long.
Thinking futures remove all risk.
The clearing corporation guarantee is misread.
Fix: Counterparty default risk is largely removed, but market risk remains. Losses from price moves are real and settled daily.

Worked examples

Example 1

A stock trades at ₹500 in the spot market. The risk-free rate is 8% per annum (simple interest) and the stock pays no dividend before expiry. What is the fair price of a 3-month (90-day) futures contract? Use 365 days in a year and round to two decimals.

Show the solution

S = ₹500, r = 8% = 0.08, t = 90 ÷ 365 = 0.246575.
Carry = 500 × 0.08 × 0.246575 = ₹9.8630.
F = 500 + 9.8630 = ₹509.86 (rounded).

Answer: Fair futures price ≈ ₹509.86

Example 2

You buy 2 lots of a stock futures contract at ₹1,200. Lot size is 250 shares. At the end of day 1 the settlement price is ₹1,212. At the end of day 2 it is ₹1,205. What is your MTM cash flow on each day and your cumulative result?

Show the solution

Quantity = 2 × 250 = 500 shares.
Day 1: (1,212 − 1,200) × 500 = 12 × 500 = ₹6,000 credit.
Day 2: (1,205 − 1,212) × 500 = −7 × 500 = ₹3,500 debit.
Cumulative = 6,000 − 3,500 = ₹2,500, which equals (1,205 − 1,200) × 500.

Answer: Day 1: gain of ₹6,000; Day 2: loss of ₹3,500; cumulative gain of ₹2,500

Exam tips

Expect difference questions: OTC vs exchange-traded, customised vs standardised, counterparty risk vs clearing guarantee, and settlement timing.
In calculations, check whether the question says simple or compounded interest before choosing the formula.
The PMS Distributors paper has negative marking of 10% of the marks for a question, so eliminate wrong options first, then guess if two remain.
Remember that cumulative MTM equals final price minus entry price, times quantity. Use it to cross-check daily figures.
Futures converge to spot at expiry, so basis becomes zero then.

Practice questions from 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 main difference between forwards and futures?

A forward is a customised OTC contract between two parties, settled at maturity and carrying counterparty risk. A futures contract is standardised and exchange-traded, with the clearing corporation as counterparty. It needs margins and is marked to market daily.

What is the cost of carry formula for futures?

Futures price = spot price + cost of carry. With simple interest and no income, F = S × (1 + r × t). If the asset pays dividends, their value is subtracted. In continuous form, F = S × e^((r − q) × t).

What is mark-to-market in futures?

It is the daily revaluation of your open position at the settlement price. Gains are credited and losses are debited to your margin account the same day. This stops losses from building up unseen.

Why do both buyers and sellers pay margin in futures?

Either side can lose when prices move. Margin ensures that each can meet its obligations, so the clearing corporation can guarantee settlement. If your balance falls below the maintenance level, you must top up.