EBS – Forwards, Futures, Swaps & Options Forwards, Futures, Swaps & Options Forwards, futures, swaps & options are derivative instruments, that is, their value is derived from the price performance of an underlying asset. Forwards, futures and swaps are terminal instruments, meaning that there has to be a closing transaction to the contract (it is a legal obligation). With options, the holder has the choice of whether they want to complete the transaction. With forwards & futures you are locking yourself into a fixed price at some point in the future, either you agree to buy at that price, or you agree to sell at that price. With options you are protecting yourself against an adverse move, but if there is a favourable move in the underlying, you can take advantage of that and simply let the option lapse. Forwards, futures and swaps would be used by hedgers (who could be large companies), who want to remove uncertainty from their future cash flows. This will make the company less risky and please debt holders. Shareholders will be pleased when it works in their favour, but be less pleased when the company would have been better off without the hedge. If the company hedges and rivals don’t and the underlying asset moves favourably (if you were unhedged), then the rivals have a competitive advantage and may be able to exert pricing pressure against the hedged company. Payoffs to Forwards, Futures & Options Forwards and futures are very similar in nature, so the payoff diagrams are the same. Imagine a situation where you have a user of aluminium, say a car manufacturer, and the producer of aluminium, a large steel company. The aluminium price has been volatile over the past few years. The car manufacturer would like to buy when the price is low and the aluminium producer would like to sell when prices are high. But the car manufacturer cannot buy and stockpile years of aluminium. They both have to take the prices that are in the market. The car manufacturer is worrie