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Spread bets and CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 69% of retail investor accounts lose money when trading spread bets and CFDs with this provider. You should consider whether you understand how spread bets and CFDs work, and whether you can afford to take the high risk of losing your money.
 Spread bets and CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 69% of retail investor accounts lose money when trading spread bets and CFDs with this provider. You should consider whether you understand how spread bets and CFDs work, and whether you can afford to take the high risk of losing your money.

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Forward contract definition

What is a forward contract?

A forward contract is an agreement between two parties to buy or sell an asset at a specified price on a predefined expiry date. Both parties have an obligation to fulfil their end of the agreement.

A forward contract can vary between different trades, making it a non-standardised entity. This means that it can be customised according to the asset being traded, expiry date and amount being traded.

Forward contracts are most commonly used for trading commodity markets, but they are also a popular tool for trading forex.

Forward contracts vs futures contracts

A forward contract is not to be confused with a futures contract. Both agreements give traders the obligation to buy and sell an asset (or settle the exchange in cash) at a set price in the future, However, there are a few key differences between them, these include:

Forward contracts are... Futures contracts are...
Traded over-the-counter (OTC) Traded on exchange
Non-standardised (can be customised) Standardised (can't be customised)
Negotiable Non-negotiable

However, trading futures and forwards with IG is slightly different because you aren’t dealing directly on an exchange. So, when you trade index futures using a spread bet or a CFD, what you are actually buying is a forward contract. For example, a futures position on IG’s FTSE 100 market is actually a forward contract for the equivalent of a FTSE 100 future.

Example of a forward contract

Let’s say you want to sell 100 tonnes of corn to a US mass retailer in 60 days at $150 per tonne. After the 60 days have passed, you would need to provide 100 tonnes of corn, and the retailer would be obliged to pay $15,000 (100 tonnes x $150) in return.

You would be obliged to sell at the agreed price, whether the value of corn is trading at $150 or not. This means that you might end up selling at a higher – or lower – than the market price when you take delivery.

If you or the buyer did not want to exchange the corn at the expiry date, you could choose to settle in cash. In this instance, no physical product is delivered. The settlement amount will be the difference between the agreed price and the current price – the buyer will pay the seller if the asset price drops, and the seller will pay the buyer if the asset price rises.

Pros and cons of a forward contract

Pros of a forward contract

Forward contracts are relatively easy to understand, which makes them a great tool for beginners. Forwards tend to be used as a means of speculation or hedging, as the contract price holds whether there is a price change to the asset or not – this means traders can be certain of the price they will be buying or selling at.

As mentioned, forward contracts offer great flexibility, as dates and amounts can be customised. Even though forward contracts have an agreed expiry on them, it does not mean that they have to be kept open for the entire duration. Most forward contracts can be closed early if you want to limit losses or take profits.

Cons of a forward contract

It is important to be aware of the risks both parties are exposed to when they take out a forward contract. First, there is no guarantee of product quality – as forwards are traded OTC rather than on exchange, there is no regulation over asset variation. However, if traders choose to settle in cash (instead of taking delivery of the asset) this would have no impact on the exchange.

And second, there is the risk of default. As a forward contract changes in price, its value increases for one party and becomes a liability for the other. This means there is a degree of counter-party risk, where the contract might not be honoured, despite obligation.

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Spread bets and CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 69% of retail investor accounts lose money when trading spread bets and CFDs with this provider. You should consider whether you understand how spread bets and CFDs work and whether you can afford to take the high risk of losing your money. 

Professional clients trading spread bets and CFDs can lose more than they deposit.

Options and futures are complex instruments which come with a high risk of losing money rapidly due to leverage. They’re not suitable for most investors. Before you invest, you should consider whether you understand how options and futures work, the risks of trading these instruments and whether you can afford to lose more than your original investment.

Trading stocks and shares ‘on margin’ within a US options and futures account – meaning that you only finance part of the cost of acquiring a position in a security – carries additional risks over buying securities on a fully funded basis and may result in losses exceeding your original investment. Trading on margin will also result in additional costs to you as the investor and any securities purchased using margin may be held as collateral by the lender, restricting both your rights as shareholder, and your ability to use the securities until the margin trade is closed. You should familiarise yourself with these risks before trading on margin.

The value of shares, ETFs and other ETPs bought through a share dealing account, a US options and futures account, a stocks and shares ISA or a SIPP can fall as well as rise, which could mean getting back less than you originally put in. Past performance is no guarantee of future results. Some ETPs carry additional risks depending on how they’re structured, investors should ensure they familiarise themselves with the differences before investing.

Share dealing and IG Smart Portfolio accounts provided by IG Trading and Investments Ltd, CFD accounts and US options and futures accounts are provided by IG Markets Ltd, spread betting provided by IG Index Ltd.   

IG is a trading name of IG Trading and Investments Ltd (a company registered in England and Wales under number 11628764), IG Markets Ltd (a company registered in England and Wales under number 04008957) and IG Index Ltd (a company registered in England and Wales under number 01190902). Registered address at Cannon Bridge House, 25 Dowgate Hill, London EC4R 2YA. IG Markets Ltd (Register number 195355), IG Trading and Investments Ltd (Register Number 944492) and IG Index Ltd (Register number 114059) are authorised and regulated by the Financial Conduct Authority.   

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