A forward commitment locks both parties into a future transaction. Neither side can walk away. The payoff is linear and symmetric. A contingent claim grants the long the right (not the obligation) to act. The buyer pays a premium upfront; loss caps at the premium, gain can be unbounded.
KEY: Both bound = commitment. One side chooses = contingent claim. Asymmetry is the marker.
A private, OTC agreement to buy or sell an asset at a fixed price on a future date. No cash at initiation. Long payoff at expiration: ST − F0. Short payoff: F0 − ST. Profit equals payoff because no premium changes hands. Customized terms, bilateral counterparty risk, single settlement at expiration.
Standardized, exchange-traded forwards with three distinguishing features:
- Standardization. Contract size, delivery date, and quality grade fixed by the exchange
- Clearinghouse. Acts as counterparty to both sides, eliminating bilateral default risk
- Daily mark-to-market. Gains and losses settle daily against margin; a margin call follows if equity drops below the maintenance threshold
Common mistakes
- Forgetting the premium in profit calculations. Payoff is gross; profit subtracts the premium for the long and adds it for the short. Trap value: writing $8 instead of $5 for the long call profit in Example 1.
- Reversing call and put payoff formulas. Long call = max(0, ST − X). Long put = max(0, X − ST). Call buyers want price up; put buyers want it down. Trap: applying X − ST to a call.
- Claiming short put loss is unlimited. Short call loss is unlimited (ST is unbounded above). Short put loss caps at X − p0 because ST cannot go below zero.
Bottom line
- Forward commitments (forwards, futures, swaps) obligate both parties. Contingent claims (options, credit derivatives) give the buyer a right, not a duty
- Long call payoff: max(0, ST − X). Long put payoff: max(0, X − ST). Profit subtracts the premium for the long, adds it for the short
- Short call max loss is unlimited; short put max loss is bounded at because ST cannot fall below zero
- Long call breakeven is ; long put breakeven is , where profit equals zero
Exam shortcut
For commitment vs. contingent: both bound = commitment, one side chooses = contingent. For option profit: compute payoff first, then subtract the buyer's premium or add the seller's. For forwards vs. futures: OTC-Custom-Bilateral vs. Exchange-Standard-Clearinghouse. Memorize the triplet and every comparison question collapses.
The full lesson (about 1,644 words, 11 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- forward commitment and contingent claim features
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