In an FFA, no ship or cargo is delivered. The parties pay or receive in cash only the difference between the contract rate and the freight index1. FFAs began in the early 1990s as over-the-counter transactions2.
Consider a hypothetical example in which a ship operator buys an FFA at USD 20,000 per day. If the average index over the settlement period is USD 26,000, the operator receives USD 6,000 per day. If the average is USD 14,000, the operator pays USD 6,000 per day. The payment offsets the change in the cost of hiring a vessel, so the cost is fixed, but the operator gives up the gain when freight rates fall.
If the vessel specification or route differs from the index, the difference from the actual freight cost is not fully removed. The mechanism and examples are covered in the article Freight Derivatives (FFA).