Updated for the 2026-2027 CFA® Level I curriculum.
A derivative contract gets its value from an underlying asset, rate, or index. CFA Level I tests whether you can identify each contract type and describe its basic structure. After this note, you should be able to define forwards, futures, swaps, options, and credit derivatives, and explain what separates each one.
Quick Answer
Derivative products fall into two groups: forward commitments and contingent claims. Forward commitments (forward contracts, futures contracts, and swaps) create a binding obligation for both parties. Contingent claims (options and credit derivatives) give one party a right without an obligation, while the seller bears an obligation only if that right is exercised. A call option gives the right to buy; a forward contract obligates both sides to transact at a set price on a set future date.
Key Takeaways About Types of Derivative Contracts and Their Basic Characteristics
Derivative contracts split into forward commitments (forwards, futures, swaps) and contingent claims (options, credit derivatives).
Forward commitments bind both parties to a future transaction at a price set today.
Contingent claims give the holder a right, not an obligation, in exchange for a premium.
Futures contracts are standardized and exchange-traded; forward contracts are customized and traded over the counter (OTC).
A call option gives the right to buy the underlying; a put option gives the right to sell it.
Credit derivatives transfer credit risk between parties without transferring the underlying asset.
Confusing an option's right with an obligation is one of the most common Level I errors.
What You Need to Know for CFA Level I
Define each contract type: forward, future, swap, call option, put option, and credit derivative.
Identify which contracts create a bilateral obligation and which create a right without an obligation.
Distinguish standardized, exchange-traded contracts from customized, OTC contracts.
Recognize the basic settlement pattern for each contract type (at expiration, daily, periodic, or upon exercise).
Separate exercise style (European versus American) from the payoff itself.
Avoid pricing and valuation detail; this LOS tests definitions and characteristics, not formulas.
Major Types of Derivative Contracts
Derivative products split into two groups based on the obligation created.
Forward commitments obligate both parties to complete a transaction on set terms at a future date. This group includes forward contracts, futures contracts, and swaps.
Contingent claims give one party a right that depends on a future event or price. This group includes options and credit derivatives. The holder decides whether to exercise. The seller's obligation applies only if the holder exercises.
Forward Contracts
A forward contract is a private agreement to buy or sell an asset at a set price on a future date. Both parties negotiate the terms directly, so the contract is customized.
Forward contracts trade over the counter (OTC). No exchange guarantees performance, so each party carries counterparty credit risk. Settlement happens once, at expiration, through physical delivery or a cash payment based on the price difference.
Futures Contracts
A futures contract is a standardized version of a forward contract. An exchange sets the contract size, expiration date, and other terms, which makes the contract liquid and exchange-traded.
A clearinghouse guarantees performance, removing direct counterparty risk. Futures also settle daily through marking to market, so gains and losses transfer between accounts each day rather than only at expiration.
Swaps
A swap is an agreement to exchange a series of cash flows over time, based on a notional amount and an agreed rate or price.
The most common example is an interest rate swap: one party pays a fixed rate and receives a floating rate, while the counterparty does the opposite. Swaps are customized, OTC contracts, so counterparty risk applies, similar to forwards.
Call and Put Options
An option gives the holder a right, not an obligation, in exchange for a premium paid upfront.
A call option gives the right to buy the underlying asset at a fixed strike price. A put option gives the right to sell at the strike price.
The option writer receives the premium and takes on the obligation. If the holder exercises, the writer must perform: sell for a call, buy for a put. The holder's maximum loss is the premium paid.
Credit Derivatives
A credit derivative transfers credit risk from one party to another without transferring the underlying loan or bond. The most common form is a credit default swap (CDS).
In a CDS, the protection buyer pays a periodic premium. The protection seller agrees to compensate the buyer if a specified credit event, such as default, occurs on the reference obligation. A CDS functions like insurance against default.
Comparing the Basic Characteristics of Derivative Contracts
The table below summarizes obligation type, market structure, standardization, and settlement for each contract type.
Contract | Obligation | Market | Standardization | Settlement |
|---|---|---|---|---|
Forward | Both parties obligated | OTC | Customized | Once, at expiration |
Future | Both parties obligated | Exchange-traded | Standardized | Daily (marked to market) |
Swap | Both parties obligated | OTC | Customized | Periodic, over the life of the contract |
Option | Holder has a right; writer has an obligation if exercised | Exchange-traded or OTC | Both types exist | At or before expiration, upon exercise |
Credit derivative | Protection seller obligated if a credit event occurs | Mostly OTC | Customized | Upon a defined credit event |
Use this table as a quick recall tool. Daily settlement and a clearinghouse point to a futures contract. A right paid for with a premium points to an option.
European vs American Option Exercise
Exercise style describes when the holder can exercise an option, not what the option pays.
A European option can be exercised only at expiration. An American option can be exercised any time up to and including expiration.
This is separate from the call/put decision; any option can carry either exercise style. American options offer more flexibility, so they are worth at least as much as an identical European option. Level I only requires recognizing this difference, not calculating it.
Worked Example
A wheat farmer expects to harvest 10,000 bushels in six months and wants price certainty today. Three contracts could apply.
Forward contract: The farmer agrees privately with a buyer to exchange 10,000 bushels for $6.00 per bushel in six months. Both sides are obligated. If the market price falls to $5.50, the farmer benefits from the locked-in price. If it rises to $6.50, the farmer still sells at $6.00.
Futures contract: The farmer sells a standardized wheat futures contract instead. The obligation matches the forward, but a clearinghouse guarantees performance and the contract settles daily.
Put option: The farmer buys a put with a $6.00 strike, paying a $0.20 premium per bushel. If the price falls to $5.50, the farmer exercises and nets $5.80. If the price rises to $6.50, the farmer lets the put expire and sells at market, keeping the upside minus the premium.
The forward and futures contracts remove both downside risk and upside potential. The put removes only the downside, at the cost of the premium. The right choice depends on whether the farmer wants full price certainty or one-sided protection.
Common Exam Traps
Treating futures and forwards as identical. Both obligate each party, but futures are standardized, exchange-traded, and settle daily. Forwards are customized, OTC, and settle once at expiration.
Confusing a call option with an obligation to buy. A call gives the right to buy. Only the writer has an obligation, and only if the holder exercises.
Confusing a put with a short forward. Both can profit when prices fall, but a short forward obligates the sale at expiration. A put lets the holder choose.
Mixing exercise style with option type. European versus American describes when an option can be exercised. Call versus put describes what right it grants.
Practice Questions
An investor wants to lock in the purchase price of an asset six months from now. She wants a contract that is exchange-traded, backed by a clearinghouse, and settled daily. Which contract best fits her needs?
Forward contract
Futures contract
Put option
Correct Answer: B
A futures contract is standardized, trades on an exchange, is guaranteed by a clearinghouse, and settles through daily marking to market. These features match all three requirements in the question.
Option A: A forward contract is customized and trades OTC without a clearinghouse guarantee, and it settles once at expiration, not daily.
Option C: A put option gives the holder a right to sell, not a mechanism to lock in a purchase price, and it does not require daily settlement through a clearinghouse.
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FAQs About Types of Derivative Contracts and Their Basic Characteristics
What is the difference between a forward commitment and a contingent claim?
A forward commitment obligates both parties to transact. A contingent claim gives one party a right, with the obligation falling on the other party only if that right is exercised.
Is a European option always cheaper than an American option?
A European option is worth no more than an identical American option, since the American option adds the value of early exercise flexibility.