Derivatives, forwards and futures
By SuperdayReps · Michigan Ross Undergrad | Wharton MBA · ex-Citi | ex-Greenhill · Former Head Mentor at a Leading IB Prep Service
13 min read · updated November 3, 2026
A large share of what a trading floor does runs through derivatives. A rates desk trades swaps and futures all day, a commodities desk hedges airlines and farmers, an FX desk sells forwards to every company that is paid in a foreign currency, and an equity derivatives desk prices options. Even a cash bond trader hedges with futures. If you are recruiting for S&T, this is the vocabulary of the job.
The interview questions are standard and they come early: what is a derivative, why would a client use one, how is a forward different from a future, how is a forward priced, and what are contango and backwardation. Interviewers listen for one idea in particular: that a forward price comes from financing and storage, not from anyone's forecast. Students who say "the futures price is where the market thinks oil will be" lose the room.
A forward price is not a prediction. It is today's price plus the cost of carrying the asset until delivery, because anyone can build a forward by borrowing, buying and holding, and any other price hands someone free money. Forwards and futures share that economics; what differs is the plumbing: where they trade, how they settle and who carries the credit risk.
What a derivative is
A derivative is a contract whose value comes from something else, the underlying: a stock, a bond, a currency, an interest rate, a commodity. An oil future moves with the oil price. An interest rate swap moves with rates. There are three families:
| Family | What it is | Who is obligated | Cost up front |
|---|---|---|---|
| Forwards and futures | Agree today to buy or sell at a set price on a set date | Both sides | None, apart from margin on a future |
| Swaps | Exchange cash flows over time, such as fixed interest for floating | Both sides | None |
| Options | The right, not the obligation, to buy (a call) or sell (a put) at a set price | Only the seller | The buyer pays a premium |
A forward is the simplest: a private agreement to trade something later at a price fixed now. A future is the same idea, standardized and traded on an exchange. Swaps get their own lesson in swaps, SOFR and rates futures, and options in options payoffs and strategies.
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Frequently asked
- What is a derivative in simple terms?
- A contract whose value comes from something else, called the underlying, such as a stock, a bond, a currency, an interest rate or a commodity. The main kinds are forwards and futures, swaps and options. Clients use them to hedge risks they already have, to get large exposure for little money up front, and to express views they cannot easily express by buying the asset.
- What is the difference between a forward and a futures contract?
- Both lock in a price today for a trade on a later date. A forward is a private contract between two parties, tailored to their needs, usually settled at the end, so each side carries the other's credit risk. A future is standardized, trades on an exchange, is settled in cash every day through margin, and has a clearing house as the counterparty to both sides, so credit risk is small.
- How is a forward price calculated?
- By cost of carry: today's spot price, plus the cost of financing the asset until delivery, plus storage for a commodity, minus any income the asset pays. A stock at $100 with 5 percent financing and a $2 dividend has a one-year forward of $103. Any other price allows a riskless profit, so arbitrage holds it there.
- What do contango and backwardation mean?
- Contango is when futures prices sit above the spot price, normal when holding the asset costs money. Backwardation is when futures sit below spot, usually because the physical asset is scarce now or pays income the futures holder does not get. Either way, the futures price converges to spot at expiry.
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