What Is a Short Date Forward?
A short date forward is a forward contract that expires in less than one year. A forward is an obligation involving two parties that agree upon a set price to sell or buy an asset at a pre-determined date and time in the future.
In forex trading, a short dated forward typically involves trading a currency at a specified spot date that is before the normal spot date, ranging from one week to one month after the trade date.
A short dated forward can be contrasted with long dated forwards with a settlement date in excess of one year, and as far as 10 or more years into the future. Companies or financial institutions use both types of these contracts to hedge certain currency exposures.
- A short date forward is an OTC derivative contract locking in the price of an asset for future delivery, with maturities less than one year.
- Short dated forwards are often used to hedge near-term risks, such as delivery of next month's receivables or an anticipated need for oil a few weeks from now.
- Due to their shorter maturities, these contracts tend to be less risky than long dated forwards.
How Short Date Forwards Works
A forward exchange contract is an agreement to exchange some underlying security or asset at a pre-specified future date, such as the currencies of different countries at a specified exchange rate (the forward rate). Typically, forward contracts call for delivery (either physical or cash delivery) on a date beyond the spot contract settlement.
Unlike futures contracts, which are standardized and traded on exchanges, forward contracts do not take place on regulated exchanges and do not involve delivery of standard currency amounts. They are said to trade over-the-counter (OTC). The terms and specifications of a particular forward contract are negotiated and agreed upon by the counterparties involved, and can be cancelled only with the consent of the other party to a trade.
Short dated forward contracts are less risky instruments than forwards with longer maturities because there is less chance for a counterparty to default on their obligations within a shorter time frame. In addition, farther long dated forward contracts often have greater bid-ask spreads than shorter-term contracts, making their use somewhat expensive.
Why Use Short Date Forwards
Investors can use short date forward contracts to hedge risks or as a speculative investment vehicle. The matured value of a forward contract can be calculated by the difference between the delivery price and the underlying price of the security on that date. A forward contract allows a trader, bank, or a bank’s customer, to arrange for delivery (or sale) of a specific amount of currency on a specified future date, at the current market price. This protects the buyer against the risk of fluctuating rates when acquiring foreign exchange needed to meet future obligations.
In contrast to a typical forward contract, short date forwards will involve delivering a currency on a spot date that is before the normal spot date, ranging from one week to one month after the trade takes place. These short-term contracts may be put in place as a stop-gap hedge when listed futures contracts do not exist for the needed contract month, or if they expire too soon or later than is needed for a perfect hedge.