Other than taking part in the forex exchange market, you can try the currency futures market. The currency futures may not be as huge as the foreign exchange market; it does have a decent daily average of about $100 billion.
Therefore, it does offer investors another method of improving their ROI. But before trying currency futures trading, you need to understand how it works.
Let’s dive right in…
What are Currency Futures?
Generally, currency futures are contracts that stipulate the exact cost of a currency at which the other foreign currency will be traded on future dates. The currency futures are legally binding. So the parties involved that are still holding these contracts when they expire must deliver.
This means they have to deliver the value of the contracts at a specified day and price.
The CME Group (Chicago Mercantile Exchange) introduced the currency futures trading in 1972. CMR Group adopted after president Nixon abandoned the gold standard, and the fixed-exchange-rate system.
Like other futures, investors trade the currency futures CME as contract months. Therefore, their maturity dates are on the 3rd Wednesday of December, September, June, and March.
How Do Currency Futures Work?
Like most standardized contracts, the currency futures contract trades on the centralized exchanges. Investors have to settle them either physically or by cash. Luckily, traders can settle the cash-settled options every day. Remember, when the price changes, the investors will; settle the difference on the expiration day.
On the other hand, the physically delivered futures are exchanged for the value indicated by the contract’s size. Since they’re trade on a centralized exchange, the investors must include the margins. The margin lowers counterparty risks, and it consists of a 4% initial margin and a 2% maintenance margin.
Margin calls only happen when the initial margin falls below the maintenance margin. When this happens, then you’ll have to deposit some cash to increase it to the maintenance level.
Examples of Currency Futures
A U.S. based firm is exposed to the risk of foreign exchange. Therefore, they plan to hedge themselves from a projected receipt of €12.5 million by September. So before the expiry date, the firm sells 100 future contracts, with each costing being worth €125,000.
Since they will be receiving the Euros in September, they lock in the exchange rate. The future currency serves as a great hedging method since it won’t lose anything if the value of the Euro depreciates.
But if it rises, then they’ll have to forgo the benefits. After all, they will sell the euros at the future contract’s price.
Why Do People Use Currency Futures?
Peoples sell currency futures for a number of reasons. In fact, some of the most common uses include the following:
- Hedging: firms that produce commodities use currency futures to manage the price risk of their assets or business. A farmer who believes the wheat’s price will fall before they harvest can sell futures contracts. The above currency futures example is an exceptional usage of these contracts for hedging purposes.
- Low execution cost: investors have to put about 10% of the contract’s value to own futures contracts
- High liquidity level: since investors trade huge amounts of contracts daily, there is a high likelihood of them placing orders quickly. Therefore, it’s quite uncommon for the contracts’ value to leap to a new level, so they’re quite liquid.
Where are Currency Futures Traded?
Investors trade most currency futures contract at the CME. The CME is the world’s leading derivative exchange that trades in various assets. Some of their asset classes include cryptocurrencies, currency futures, and agricultural products.
At the CME, these trades, the currency futures formula is based on the exchange rate of the major currencies.
Other than on the CME, these contracts are available on several derivative exchanges. Some of these exchanges include the Euronext exchanges and the Intercontinental Exchange (ICE).
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