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.

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

Key intuition: future = mass-produced contract from a store; forward = tailor-made suit. Same fabric, different fit and different aftercare.
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.
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:

$$ F_0 \;=\; S_0\,e^{(r+b-q)T} $$

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:

$$ V_t \;=\; \big(F_t - K\big)\,e^{-r(T-t)} \;=\; S_t e^{-q(T-t)} - K e^{-r(T-t)} $$

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).

$$ V = V_{\text{risk-free}} - \text{CVA} + \text{DVA} - \text{FVA} $$
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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