Forwards Contract
A forward contract is a binding agreement in which two parties agree to exchange specific assets on a future date at a price established when forming the contract.
Binding Agreement
Unlike option contracts, where exercising the contract is optional, a forward contract's exchange of assets is mandatory. The transaction will occur on the specified date in the contract, regardless of the current market price of the asset at that time.
Long Position
Party's Obligation: The long party is obligated to buy the asset at the agreed-upon price on the settlement date
Profit Scenario: If the market price of the asset rises above the agreed-upon price, the long party can buy the asset at the lower agreed price and sell it at the higher market price, profiting from the difference
Example: A trader enters a forward contract to buy 1 ADA at $1 in one month. After a month, ADA rises to $1.5. The trader buys 1 ADA for $1 as per the contract, which is $0.5 lower than the current market price, earning a profit of $0.5.
Short Position
Party's Obligation: The short party is obligated to sell the asset at the agreed-upon price on the settlement date
Profit Scenario: If the market price of the asset falls below the agreed-upon price, the short party can buy the asset at the lower market price and sell it at the higher agreed price, profiting from the difference
Example: A trader enters a forward contract to sell 1 ADA at $1 in one month. After a month, ADA drops to $0.5. The trader buys 1 ADA at the market price of $0.5 and sells it for $1 as per the contract, earning a profit of $0.5.
Comparison of Long and Short Positions
Objective:
Long Position: Used when expecting an increase in asset price
Short Position: Used when expecting a decline in asset price
Party's Obligation:
Long Position: Obligation to buy
Short Position: Obligation to sell
Market Conditions:
Long Position: Profitable in bullish markets
Short Position: Profitable in bearish markets
Risk Management:
Long Position: Used to secure the future purchase price of an asset expected to increase in value
Short Position: Used to lock in a selling price for an asset in the future
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