What are currency futures? Introduction to currency futures trading

By | May 24, 2017

Currency futures belong to the futures market, which is a derivative market. Here, the underlying commodity, which is the currency exchange rate is tracked. For example, a euro currency futures contract tracks the prices of the EURUSD exchange rate from the spot for market.

Currency futures are only different in the type of markets that are traded. Besides this differentiating factor, currency futures behave similarly to any other futures contracts such as commodity futures or index futures.

For example, currency futures are standardized contracts and have contract months just like another other futures contract would.

The currency futures are based upon the spot forex or currency markets but there are some significant differences between the two types of assets.

How does a currency futures contract work?

A currency futures contract refers to a standardized futures contract for the foreign exchange market. Here, the underlying asset is the exchange rate. Currency futures are traded and settled on a regulated futures exchange unlike the underlying assets which are traded over the counter.

A futures trader can go long or go short on a currency futures contract if they believe that the price of that futures contract will rise or fall during the tenure of holding the position. This is commonly used to hedge one’s exposure to the exchange rate.

How are currency futures different to spot forex markets?

For one, the forex markets are the cash markets from where the prices are derived, while the currency futures are the derivative markets where one can trade in order to hedge exposure to the price fluctuations.

There are many different futures trading exchanges around the world. The two most commonly used exchanges are however the CME Group (Chicago Mercantile Exchange) and the ICE (Intercontinental Exchange) futures exchange.

All currency futures being traded must be settled at the futures exchange. This is one of the significant differences between the spot forex markets and the currency futures markets. The benefits of this are also quite clear.

Due to the regulated markets, the currency futures have a reduced counterparty risk as compared to the spot forex markets which are settled over the counter, which increases the counterparty risk.

Besides this another common gripe that forex traders have is their broker taking a position against their trades. By acting as a market maker, the forex brokers basically have a conflict of interest with their clients. This can however be eliminated with currency futures trading.

How are currency futures contract settled?

As with any futures contract, there is a contract month during which it trades. When the futures contract expires, traders can either settle for cash by closing their contract ahead of time or take physical delivery of the asset by holding it to expiry.

Depending on the currency being traded, traders who hold the contract to expiry can expect delivery. Because all currency futures contracts are quoted in U.S. dollars, the currency being traded becomes the underlying currency.

So, if you were to trade the British pound futures, you will see pricing in U.S. dollars and when you take delivery you will take 62,500 British pounds for every contract held.

What are the most popular currency futures contracts?

Initially, currency futures contracts started out with just the majors, namely the Euro futures, Yen futures and the British pound futures. But this has expanded now to cover all the major currency pairs. These are:

  • Euro futures (tracks the EUR/USD spot prices)
  • British pound futures (tracks the GBP/USD spot prices)
  • Japanese yen futures (tracks the JPY/USD spot prices)
  • Canadian dollar futures (tracks the CAD/USD spot prices)
  • Australian dollar futures (tracks the AUD/USD spot prices)
  • New Zealand dollar futures (tracks the NZD/USD spot prices)
  • Swiss franc futures (tracks the CHF/USD spot prices)

Besides the above major currencies, other currency futures contracts include exotic currencies such as the South African rand futures, Russian Ruble futures and more recently some cross currency futures such as EURGBP futures contracts as well.

Different types of currency futures contracts that you can trade

Currency futures contracts are primarily available for trading in two forms, namely the standard futures contracts, the e-mini futures contracts and the e-micro futures contracts.

Depending on the contract type that you trade, you can expect the following changes:

  • The size of the contract changes accordingly
  • The tick size of the contract changes
  • The minimum-tick of the contract changes
  • The initial margin and maintenance margin requirements also change
  • In some cases, only e-mini or e-micro futures contracts are available (ex: INR/USD futures contracts are available only as e-micro contracts)

The chart below shows three different types of currency futures contracts for the Euro Fx including the EURUSD spot price chart.

Euro FX Currency Futures Contract Types

Euro FX Currency Futures Contract Types

Futures markets have been described as continuous auction markets and as clearing houses for the latest information about supply and demand.

They are the meeting places of buyers and sellers of an ever-expanding list of commodities that today includes agricultural products, metals, petroleum, financial instruments, foreign currencies and stock indexes.

Trading has also been initiated in options on futures contracts, enabling option buyers to participate in futures markets with known risks.

Notwithstanding the rapid growth and diversification of futures markets, their primary purpose remains the same as it has been for nearly a century and a half, to provide an efficient and effective mechanism for the management of price risks.
By buying or selling futures contracts–contracts that establish a price level now for items to be delivered later–individuals and businesses seek to achieve what amounts to insurance against adverse price changes. This is called hedging.

Volume has increased from 14 million futures contracts traded in 1970 to 179 million futures and options on futures contracts traded in 1985.

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