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Equity Derivatives

Equity Forward

Also known as: OTC forward

The bespoke cousin of the future: a private agreement on tomorrow's stock price, tailored to size and date.

2 min read · 492 words

1 · SnapshotThe one idea to remember
Key intuition: future = mass-produced contract from a store; forward = tailor-made suit. Same fabric, different fit and different aftercare.
2 · BeginnerWhat is it, really?

A forward is the same promise as a future — a price fixed today for an exchange on a future date — but negotiated privately between two parties instead of on an exchange. Any stock, any size, any date: the terms are whatever the two sides agree.

Because nothing is standardised, forwards are used when listed futures don't fit: hedging a stake in a single company, an odd maturity to match a corporate event, or a currency and settlement style a future doesn't offer.

The price of this flexibility is counterparty risk: with no clearing house in the middle, each side must trust the other to perform — which is why forwards live mostly between banks and institutional clients, wrapped in collateral agreements.

Payoff of a long forward at maturity: S_T − F₀, linear and symmetric.
F₀Long forwardUnderlying price at expiryProfit / loss
Asset class
Equity derivatives
Instrument type
Forward (linear)
Traded
OTC, bilateral
Typical users
Corporates, funds needing custom terms
3 · IntermediateHow it works in practice

Mechanics

  • No upfront payment: at inception the forward price is set so the contract is worth zero to both sides.
  • Settlement: physical (shares delivered against cash) or cash-settled (pay the difference to the fixing).
  • Collateral: under ISDA/CSA documentation, the mark-to-market is collateralised daily — economically similar to futures margining but bilateral.

Where forwards appear in real life

  • Funded/unfunded equity stakes: an investor gains exposure to a stock it cannot or will not hold directly.
  • Corporate hedging: a founder hedges a concentrated position (often via collars — a forward-like structure built from options).
  • Dividend risk transfer: forward prices embed expected dividends, so forward desks are natural dividend traders.
Worked example: a fund agrees to buy 1M shares at €52 in 9 months (spot €50). At maturity the stock is €58 → the fund's forward is worth (58 − 52) × 1M = €6M. At €47, it owes €5M. In between, the mark-to-market moved daily and was collateralised.
4 · AdvancedPricing & valuation

Pricing by replication

The forward price is fixed by the same static arbitrage as futures — buy the share, borrow the cash, receive dividends:

$$ F_0 \;=\; S_0\,e^{(r+b-q)T} $$
What the symbols mean
  • Fthe forward or futures price
  • Sthe price of the underlying today
  • rthe interest rate, per year
  • qthe dividend yield, per year
  • Tmaturity, in years

where \(r\) is the funding rate, \(q\) the dividend yield and \(b\) the borrow cost / repo spread of the specific stock — for hard-to-borrow names, \(b\) can dominate and push forwards far below the "textbook" level.

Valuing a seasoned forward

After inception, a long forward struck at \(K\) is worth the discounted gap between today's forward and the strike:

$$ V_t \;=\; \big(F_t - K\big)\,e^{-r(T-t)} \;=\; S_t e^{-q(T-t)} - K e^{-r(T-t)} $$
What the symbols mean
  • Va value
  • ta point in time
  • Fthe forward or futures price
  • Kthe strike: the price written into the contract
  • rthe interest rate, per year
  • Tmaturity, in years

The credit dimension

Uncollateralised forwards carry expected-loss adjustments: CVA (counterparty may default when the contract is in your favour) and FVA (funding the uncollateralised mark). Modern pricing is therefore collateral-discounting: cash flows discounted at the rate the CSA collateral earns (typically OIS).

$$ V = V_{\text{risk-free}} - \text{CVA} + \text{DVA} - \text{FVA} $$
What the symbols mean
  • Va value

The formulas above are standard textbook formulations, simplified for teaching. They explain the mechanism — they are not a valuation tool, and they will not reproduce a dealer’s price.

5 · Desk notesHow practitioners think about it
Practitioner note: for single stocks, the forward is where three prices meet — funding, borrow and expected dividends. A "mispriced" forward is usually one of those three telling you something.

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