Standardized contracts that trade on centralized markets are currency futures. Futures might be settled in cash or physically delivered. Futures that are cash-settled are settled daily on a mark-to-market basis.
The differences are settled in cash till the expiration date as the daily price changes. At the expiration date for futures settled by physical delivery, the currencies must be exchanged for the amount indicated by the contract size.
- Expiration Date This is the last time a cash-settled future is settled. This is the date on which the currencies are exchanged for physically delivered futures.
- Size – Contracts are all the same size. A euro currency contract, for example, is standardized at 125,000 euros.
- Requirement for a Margin An initial margin is necessary to enter into a futures contract. A
What are currency futures used for?
Currency futures are currency futures contracts that define the cost of exchanging one currency for another at a later date. The rate for currency futures contracts is generated from the currency pair’s spot rates. Currency futures are used to mitigate the risk of receiving foreign currency payments.
What is the best way to trade FX futures?
Currency futures are futures that are exchanged on an exchange. Traders often have accounts with brokers who place orders to purchase and sell currency futures contracts on multiple markets. In order to place a trade in currency futures, a margin account is typically used; otherwise, a large sum of money would be necessary. Traders use a margin account to borrow money from their broker in order to place trades, which is normally a multiple of the account’s actual cash value.
When currency futures expire, what happens?
A futures contract is a perishable, legally binding security. As a result, each contract has a unique expiration date on which the contract’s terms are settled. When a contract comes to an end, it can no longer be traded on the open market.
Futures contracts are finite instruments due to the concept of expiration. There are no stock or FX expiry dates to be aware of if you’re trading shares or currencies, but there are futures expiration dates to be aware of! If you’re going to trade these interesting goods, you’ll need to know when futures contracts expire.
What are currency derivatives?
Currency derivatives are contracts whose value is determined by the underlying asset, which is the currency. A currency derivative contract is standardized through a foreign regulatory exchange with an intermediary clearing house, unlike a forward transaction. Because the agreement is traded on a controlled market, there are few counterparty risks because it must adhere to the foreign exchange’s laws and regulations. Futures and options are the two types of currency derivatives contracts. Both contracts are margin-based, which means traders must deposit a tiny fraction of the contract’s value with the exchange as an initial margin. Currency derivatives are commonly employed by traders as a risk management financial instrument since they help guard against future price volatility of the underlying asset.
How do you protect yourself against currency futures?
Forex risk is a danger that any individual or business that deals with foreign currency is exposed to. Whether you’re an exporter, importer, ECB borrower, FCNR borrower, or a worldwide tourist, currencies have a significant impact on your finances. Payables in foreign currency are owed to an importer or a foreign borrower. As a result, they’ll be looking to keep the INR high so that they may collect more dollars for the same amount of rupees when their foreign currency obligation is due. Importers and foreign currency borrowers will need to protect their businesses from the rupee’s depreciation.
The exporter, on the other hand, has foreign currency receivables that will be paid at a later period. The exporter must ensure that the rupee remains weak, as this will result in his receiving more INR for each dollar received. The exporter will be glad if the rupee weakens, but he will need to protect himself if the currency strengthens. The USD-INR pair can be used by both importers and exporters to achieve the same result. Futures or options can be used to hedge the risk, and we’ll look at how each of these strategies can be used. While the USD-INR pair is presented as an example because of its liquidity and popularity, the same rationale may be applied to receivables in the Pound, Euro, and Yen.
Let’s look at an illustration to assist us comprehend this. Assume Raghav Exports Ltd. has a $50,000/- export inward remittance that is due on September 30th. While Raghav is aware of the dollar amount he will receive on September 30th, he is unsure of how much INR that will translate into, as it will be determined by the USD-INR exchange rate on that date. The current exchange rate is Rs.64 to $1. On September 30th, this will translate into a rupee inflow of INR 32 lakhs. Raghav has obligations on October 10th and is satisfied with the exchange rate of 64/$ on settlement day.
Raghav Exports, on the other hand, has been warned by their banker that the INR may actually appreciate to 62/$ by September 30th as a result of large FDI inflow into India. In rupee terms, this means Raghav exports will only receive Rs.31 lakhs. Raghav Exports is concerned that this will result in a shortfall in meeting their October 10th outflow pledge. As a result, the corporation must manage its inbound dollar risk. How would Raghav Exports be able to accomplish this?
Simply put, Raghav Exports can mitigate this risk by selling 50 lots of the USD-INR pair at Rs.64 per lot (each lot is worth $1000). This will provide them with complete protection. This is how it is going to function. Assume that the INR has appreciated to 62/$ on the 30th of September, the inbound date. On September 30th, Raghav Exports will receive a transfer of $50,000/-, which will be translated to Rs.31 lakhs. Raghav, on the other hand, has sold 50 units of USD-INR futures for Rs.64 each. Raghav exporters will gain a Rs.1 lakh profit on the position now that the price has dropped to 62. As a result, the total receivable is now Rs.32 lakh (Rs.31 lakh from conversion and Rs.1 lakh from the short USD-INR futures). Raghav Exports has effectively hedged its conversion price at Rs.64/$.
What happens if the INR depreciates to Rs.68, on the other hand? Raghav Exports would have made a profit in normal circumstances, but due to the hedging, it will be locked in at Rs.64/$. This will result in a Rs.4 notional loss, but the goal is to protect your downside risk rather than to profit. There are two ways to get around this. The USD-INR pair can be held with a stringent stop loss, or hedging can be done with put options rather than futures, limiting the maximum risk to the amount of the option premium.
In this case, the situation will be the polar opposite of the exporter’s. A dollar will be due at a later date to an importer or a foreign currency borrower. As a result, they must guarantee that the INR does not decline too much, as this will necessitate the use of more rupees to obtain the same amount of dollars. By purchasing USD-INR futures, the importer or foreign currency borrower might reduce their risk. When the rupee falls in value, the dollar rises in value, increasing the value of USD-INR futures. Any dollar loss he incurs as a result of the weaker INR will be offset by long USD-INR futures. Hedging can also be done using options in the event of an importer or foreign currency borrower by purchasing a call option on the USD-INR pair.
Currency derivatives (futures and options) are also a useful way to hedge future dollar risk. While the OTC forward market continues to dominate, currency derivatives are quickly becoming the preferred method of managing currency risk.
What is the purpose of currency swaps?
Currency swaps are used to get foreign currency loans at a lower interest rate than a corporation could get by borrowing directly from a foreign market, or to hedge transaction risk on foreign currency loans that have already been taken out.
Is FX more dangerous than stocks?
Foreign exchange, or FX, is the world’s largest financial market. It’s only available 24 hours a day, 7 days a week via online platforms. Stocks, on the other hand, are strictly regulated and only traded while actual markets such as the New York Stock Exchange or Nasdaq are open. Each carries its own set of dangers.
Leverage risk
Taking a forex position is not an investment in the sense of holding a security for a medium- to long-term gain, as many stock investors do. Exchange rate swings of this magnitude are uncommon. To magnify possible gains, forex investors must acquire a short-term leveraged position.
While stock brokers only allow a leverage ratio of 2:1, forex platforms enable leverage ratios of up to 50:1 in some countries, and even 200:1 in others. Leveraging is accomplished by borrowing money from a broker, and it is also known as “margin trading.”
While margin trading boosts possible profits, it also increases the hazards. A tiny market movement can have a huge impact on a forex portfolio’s value. If an investor fails to meet the margin requirements, their trade is closed. Unlike leverage in stock trading, this closing occurs unexpectedly. Overall, leverage is risky when it comes to FX trading.
Country risk
Forex trading is riskier than stock trading and more difficult to anticipate. Stock investors use the fundamentals of a company’s stock to estimate future values, but the value of a country’s currency is influenced by a number of other factors.
The gross domestic product (GDP), the Consumer Price Index (CPI), and the unemployment rate are all systemic elements. However, unforeseen or unpredictable occurrences have historically had the greatest impact on exchange rates. A political crisis, a central bank decision, or a natural disaster can all have an unforeseen impact on an exchange rate.
Furthermore, the currency of a country is always mentioned in respect to another currency. So, while a shareholder can concentrate on one company’s financial prospects, a forex trader must keep track of two countries.
Counterparty risk
Forex trades, unlike stocks, are not guaranteed to be cleared by a physical exchange or clearing house. As a result, an investor is exposed to high counterparty risk. Their dealer, for example, may fail to deliver the purchased currency.
Gap risk
Gaps are more likely to occur in stock trading than in FX trading. Gaps occur between trading days, and it’s not uncommon for stocks or stock indices to “gap” several percentage points higher or lower in the first minute of trade. Stock trading becomes more volatile and unpredictable as a result of gapping. Gaps in forex trading can occur when markets close for the weekend or holidays halt normal trading activity, but they are rare.
Spread risk
The trading platform determines the spreads. The difference between the buy and sell price is used to offset the platform’s charges. The lower the spread, the more liquid the market for a particular stock or currency pair is. As a result, forex trading has an edge in terms of liquidity, especially when compared to smaller companies that are traded less often. Limit orders, rather than market orders, can be used to reduce this risk in stock trading.
Risk management strategies
Though all investments are risky, there are a few things you can do to reduce your risk:
- Stop-loss and profit-limit orders are two types of orders. These can be used by investors to lower their risk exposure in both forex and equities. If the price reaches a specified point, either a fixed or a percentage value, these orders close out the position. These orders are less useful in forex than in stocks because equities may sustain trends for far longer than forex moves.
- Diversification and hedging. Despite the hazards, forex is a good option for those wishing to diversify their portfolio. The risk characteristics of forex, as well as its international nature, provide an investor with two layers of diversification. Forex can also be used to hedge against interest rate risks for a country’s fixed-income assets if an investor has considerable exposure to that country or currency.
Are futures preferable to stocks?
While futures trading has its own set of hazards, there are some advantages to trading futures over stock trading. Greater leverage, reduced trading expenses, and longer trading hours are among the benefits.
What if you don’t sell your futures contract?
It will not be rolled-over if you do not square-off futures. The payment will be made in cash. If you want to roll over, you must square-off manually and then buy stock futures for the next month.
How long may a futures contract be held?
A demat account is not required for futures and options trades; instead, a brokerage account is required. Opening an account with a broker who will trade on your behalf is the best option.
The National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE) both provide derivatives trading (BSE). Over 100 equities and nine key indices are available for futures and options trading on the NSE. Futures tend to move faster than options since they are the derivative with the most leverage. A futures contract’s maximum period is three months. Traders often pay only the difference between the agreed-upon contract price and the market price in a typical futures and options transaction. As a result, you will not be required to pay the actual price of the underlying item.
Commodity exchanges such as the National Commodity & Derivatives Exchange Limited (NCDEX) and the Multi Commodity Exchange (MCX) are two of the most popular venues for futures and options trading (MCX). The extreme volatility of commodity markets is the rationale for substantial derivative trading. Commodity prices can swing drastically, and futures and options allow traders to hedge against a future drop.
Simultaneously, it enables speculators to profit from commodities that are predicted to increase in value in the future. While the typical investor may trade futures and options in the stock market, commodities training takes a little more knowledge.