Forex Future
forex future
A forex future – also known as a foreign exchange future, currency future or FX future – is a futures contract that involves two different currencies.
With a forex future, the two parties agree to exchange one currency for another with each other at a specified date in the future, at a pre-determined exchange rate.
Short facts about forex futures
- On the futures market, a vast majority of the traded forex futures involve the United States dollar. With such forex futures, the price of the forex future is stated as US dollars per unit of the other currency. The other currency is called the trade unit.
- It is common for forex future contracts to stipulate actual delivery of the currencies upon maturity (the delivery date). However, most forex futures are closed out before they reach maturity.
- Two examples of important exchanges for forex futures trading are the International Monetary Market (a division of the Chicago Mercantile Exchange) and the Intercontinental Exchange.
- For forex futures traded on the International Monetary Market, the conventional maturity dates are the third Wednesday in March, June, September and December. These are known as the IMM dates for forex futures.
How traders and investors are using forex futures
Speculation trading
Forex futures are heavily utilized for speculation trading and is a way for traders to gain exposure to currency exchange rate fluctuations.
Example:
A trader purchases ten forex futures of the CME Euro FX Futures kind, with the third Wednesday in September as their maturity date. Each contract is for €125,000, so this is €1,25 million in total.
During the day, the futures go from $1.2713/€ to $1.2784/€. This is a price change of $0.0071/€.
As each contract was for 125,000 euros, the profit is $887,50 per contract.
(Calculation: 0.0071 x 125000 = 887.5)
With a total of ten contracts, the combined profit is $88,750. This money is paid into the trader´s brokerage account right away.
Hedging
Forex future contracts can be used to hedge against foreign exchange risk and have become an important tool for risk management.
Example: Company A knows they will receive a large cash payment denominated in a foreign currency at some future date. They decide to lock in the current exchange rate by entering an offsetting currency futures position that expires on the same date the payment is due. The company no longer has to worry about a fluctuating exchange rate.
It is not only companies doing international transactions that need to manage exchange rate risk; many traders and investors also use forex futures contracts in this manner.
Understanding the background
Invention
The modern currency future contract was developed by the International Commercial Exchange in New York in 1970.
Back then, the Bretton Woods system was still in place, and not many traders were interested in trading these new contracts.
This situation changed abruptly on August 15, 1971, when the United States – with President Richard Nixon at the helm – abandoned the gold standard and the system of fixed exchange rates.
The Bretton Woods system had been in place since 1944, but when the United States terminated the convertibility of the U.S. dollar to gold they effectively brought the system to an end, and several fixed currencies (including the sterling) became free-floating shortly thereafter.
This created ample opportunities for forex trading with big and heavily used currencies tied to major economies.
It should be noted that the end of the Bretton Woods system was not formally ratified until 1976.
The IMM
In December 1971, the International Monetary Market (IMM) was created by the Chicago Mercantile Exchange (CME), and trading in seven different currency futures was launched on May 16 the following year.
A driving force behind the establishment of IMM was the attorney and finance executive Leo Melamend, who is today hailed as a pioneer of financial futures.
Share this:
Category: Forex
