Futures Vs Forex TradingTRADE12

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*Futures and Options on Foreign ExchangeChapter Objective: This chapter discusses exchange-traded currency futures contracts, options contracts, and options on currency futures.

Chapter OutlineFutures Contracts: PreliminariesCurrency Futures MarketsBasic Currency Futures RelationshipsEurodollar Interest Rate Futures ContractsOptions Contracts: PreliminariesCurrency Options MarketsCurrency Futures Options

9Chapter Nine

*9.1 Futures ContractsA futures contract is like a forward contract:

It specifies that a certain currency will be exchanged for another at a specified time in the future at prices specified today.A futures contract is different from a forward contract:

Futures are standardized contracts trading on organized exchanges with daily resettlement through a clearinghouse - marked to market.Standardizing Features: contract size, delivery month, daily resettlement - marked to marketInitial Margin: about 2-5 % of contract value, cash or T-bills held in a street name at your brokers.Participants losses or profits are realized daily instead of at maturity as with a forward contract.Because of marking to market, the futures price converges through time to the spot price on the last day of trading in the contract.

*Daily Resettlement = Marking to Market Example: On Monday morning you take a long position in SF futures contract that matures on Wednesday afternoon at $0.75/SF.1. At the close of trading on Monday the futures price has risen to $0.755. Because of the daily settlement you receive a cash profit of $625 =125,000 x (0.755-0.75) 2. At Tuesday close the price has declined to $0.743. You must pay the $1500 loss (125,000 x [0.743-0.755]) to the other side of the contract. 3. At Wednesday close, the price drops to $0.74, and the contract matures. You pay $375 loss to the other side and take the delivery of the SF, paying the prevailing price of $0.74. You have a net loss on the contract of $1250 (625-1500-375)You can also close out your long position with an offsetting trade, if you dont want the delivery of the SF.

*9.2 Currency Futures MarketsThe Chicago Mercantile Exchange (CME) is by far the largest. Others include:

The Philadelphia Board of Trade (PBOT)The MidAmerica commodities ExchangeThe Tokyo International Financial Futures ExchangeThe London International Financial Futures ExchangeExpiry cycle: March, June, September, December.Delivery date 3rd Wednesday of delivery month.Last trading day is the second business day preceding the delivery day.CME hours 7:20 a.m. to 2:00 p.m. CST.

*Currency Futures Contract Specifications

*Currency Futures Quotations (CME)

*9.3Basic Currency Futures RelationshipsOpen Interest refers to the number of contracts outstanding for a particular delivery month.Open interest is a good proxy for demand for a contract.Some refer to open interest as the depth of the market. The breadth of the market would be how many different contracts (expiry month, currency) are outstanding.

* Reading a Futures Quote ($/)

Expiry month

Opening price

Highest price that day

Highest and lowest prices over the lifetime of the contract.

Number of open contractsLowest price that dayClosing priceDaily Change

Open

Hi

Lo

Settle

Change

Lifetime High

Lifetime Low

Open Interest

Sept

.9282

.9325

.9276

.9309

+.0027

1.2085

.8636

74,639

*Long and Short Positions in a Futures Contract

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9.4 Eurodollar Interest Rate Futures Contracts

Widely used futures contract for hedging short-term U.S. dollar interest rate risk.The underlying asset is a hypothetical $1,000,000 90-day Eurodollar depositthe contract is cash settled.Traded on the CME and the Singapore International Monetary Exchange.The contract trades in the March, June, September and December cycle.

*Reading Eurodollar Futures QuotesEurodollar futures prices are stated as an index number of three-month LIBOR calculated as F = 100 LIBOR.The closing price for the July contract is 94.68 thus the implied yield is 5.32 percent = 100 94.68The change was .01 percent of $1 million representing $100 on an annual basis. Since it is a 3-month contract one basis point corresponds to a $25 price change.

*9.5Currency Options-PreliminariesCall options gives the holder the right, but not the obligation, to buy a given quantity of some asset in the future, at prices agreed upon today.Put options: the holder has the right, but not the obligation, to sell a given quantity of some asset in the future, at prices agreed upon At-the-money (ATM) E = S

The exercise price (E) equals the spot price (S) of the underlying asset. In-the-money (ITM) E < S

The exercise price (E) is less than the spot price (S) of the underlying asset. Out-of-the-money (OTM) E > S

The exercise price is more than the spot price of the underlying asset today.

*Currency Options MarketsOriginally traded OTC PHLXOTC volume is much bigger than exchange volume.($130Bil. vs. $3Bil. Per day)Trading is in six major currencies against the U.S. dollar.Options contract sizes are half of the futures contracts

*PHLX Currency Option Specifications

*Currency Futures OptionsCurrency futures options are an option on a currency futures contract.Exercise of a currency futures option results in a long futures position for the holder of a call or the writer of a put.Exercise of a currency futures option results in a short futures position for the seller of a call or the buyer of a put.If the futures position is not offset prior to its expiration, foreign currency will change hands.

* Call Option Value at Expiry

*Pay-off to Purchaser of aCall Option on C$ for US$

*Pay-off to Writer of aCall Option on C$ for US$

* Pay-off to Purchaser of aPut Option on C$ for US$

*Pay-off to Writer of a Put Option on C$ for US$

*Call Option Hedge for $US1m to be Received in Three Months