A forward contract at a forward rate that allows the holder to break or unwind the contract with an opposite position at another rate, known as the break rate. It is a kind of synthetic option or combination in which there is no premium payable and the price of the embedded option is included in the fixing of both the forward rate and the break rate. This contract is particularly popular in the foreign exchange market since the buyer is not required to pay up-front premium. As a foreign exchange forward contract, it gives one party the right, without the obligation, to terminate the contract at one or more preset times during its life. A break forward contract specifies a forward price K and a break price B at which the forward price can be discontinued or broken. At maturity date, the long will receive the break price if – B > S_T – K. Therefore, if the break price is $15 and the forward price is $150, the payoff to the long forward position is:

payoff = S_T– 150

If the forward price is lower than $135, the long will incur a loss of more than $15, and he will be better off to pay the break price of $15. It follows that at maturity the payoff would be:

payoff = [ST- 150, -15]

In this sense, the break forward contract is similar to a call option with a strike price of $135 except that a break price is paid at maturity.

Since the establishment of a break forward contract requires no initial costs, it is practically similar to a deferred payment option, where the payment of the initial cost of the option is deferred until maturity date.

It is also known as a cancellable forward.