Parties in Forward Contract – Buyer vs Seller Obligations
In every contract, there is a winner and a loser (unless price stays exactly same).
1. The Two Parties
A. The Buyer (Long Position)
- Agrees to BUY the asset.
- View: Bullish (Thinks price will rise).
- Profit: If Market Price > Contract Price.
- Example: Baker buys Wheat Forward at ₹22. If MP is ₹30, he profits ₹8.
B. The Seller (Short Position)
- Agrees to SELL the asset.
- View: Bearish (Thinks price will fall).
- Profit: If Market Price < Contract Price.
- Example: Farmer sells Wheat Forward at ₹22. If MP is ₹15, he avoids the loss (effectively profits ₹7 relative to market).
2. Comparison: Long vs Short
Long (Buyer)
- Obligation: To Buy.
- Hopes for: Price Rise.
- Risk: If price falls, he must still buy at high price.
VS
Short (Seller)
- Obligation: To Sell.
- Hopes for: Price Fall.
- Risk: If price rises, he must still sell at low price.
3. Zero Sum Game
- Rule:
Profit of Buyer = Loss of Seller. - Equation:
(Spot Price at Expiry - Contract Price)is Buyer's Payoff.
4. Exam Notes: Writing the Answer
Question: "Distinguish between Long and Short positions in a Forward Contract." (5 Marks)
Answering Strategy:
- Define: Long = Buy, Short = Sell.
- Motive: Bullish vs Bearish.
- Diagram: Draw a simple payoff graph (Upward slope for Long, Downward slope for Short).
Summary
- Binding: Unlike Options, both parties are obligated to fulfill the contract. You cannot walk away.
Quiz Time! 🎯
Test Your Knowledge
Question 1 of 4
1. The party agreeing to BUY the asset in a forward contract takes a: