What are Currency Futures?

P. Matz

Currency futures are exchange traded contracts to buy or sell a specific currency at a future date for at a pre-set price determined by the market. Unlike forex “spot” transactions which are short term contracts conducted through the inter-bank system, currency futures are longer term contracts executed primarily on the Chicago Mercantile Exchange (CME).

The foreign exchange market, or “Forex” market, is an inter-bank system in which investors and corporations can trade global currencies.
The foreign exchange market, or “Forex” market, is an inter-bank system in which investors and corporations can trade global currencies.

Forex trading that occurs in live time, is referred to as the “Spot” market. Forex transactions on the spot market are usually settled within two days. The foreign exchange market, more commonly referred to as the “FX” or “Forex” market, is an inter-bank system in which investors and corporations can trade currencies. By volume, the forex market is the largest market in the world with over a trillion dollars being transacted daily on it.

Tokyo is home to a major currency futures exchange.
Tokyo is home to a major currency futures exchange.

Currency futures, however, were first created in 1972 by CME traders who did not have access to the inter-bank system. The decision to create currency futures was a direct result of two historical developments. In 1970, the U.S. went off the gold standard, allowing the price of the Dollar to “float” on the market rather than being set at a fixed rate. Subsequently, other countries followed suit, allowing their national currencies to float also, thus, creating an actual market for foreign exchange. In response to these historic changes, the International Monetary Market (IMM) was created for the primary purpose of transacting currency futures contracts. The two other exchanges that deal in currency futures are the Tokyo Financial Exchange, and Euronext.liffe.

Unlike forex spot transactions whose contract sizes vary widely in terms of amount, currency futures are traded in contracts of standardized amounts, with preset dates of maturity. Typically, three months is the standard length of time on a currency futures contract. Futures contracts of this type always involve the exchange of two currencies. For instance, an individual might purchase a contract to buy 100,000 Euros for a specified price and sell a matching amount of U.S. Dollars. The individual will profit from this transaction if the price of the Euro rises relative to the U.S. Dollar. Conversely, if the Dollar strengthens in relation to the Euro during the period of the contract, the individual would stand to lose money proportionate to the disparity in the exchange rates.

The two type of entities most likely to engage in the trading of currency futures would be hedgers and speculators. Hedgers are most commonly corporations looking to minimize their foreign exchange risk. Particularly for companies that do commerce overseas, fluctuations in foreign exchange rates can greatly impact the profitability of their ventures. For instance, if a German car manufacturer is planning to produce and ship a quantity of vehicles to the U.S. three months from now, if the Dollar decreases against the Euro in the intervening months, it will result in a loss for the manufacturer equivalent to the differential between the two currencies. However, if the German manufacturer takes out a currency futures contract on the deal, he can lock in his desired Dollar rate now, and which insures him against volatility in the currency in the near future.

Speculators, the other major player in the currency futures market, take a more short term view of the markets. The goal of speculators is to buy and sell currencies relative to one another in hopes of profiting from the fluctuating differentials between the currencies on a daily basis. The values of futures contracts rise and fall daily with the foreign exchange rates on which they are based. Speculators will buy and sell the contracts of various currencies and willingly assume risk in order to gain a profit in the exchange.

Both hedgers and speculators employ currency futures contracts in the marketplace. However, both entities due to their differing motivations, view the forex market from a different perspective. Hedgers utilize currency futures as a defensive mechanism, to protect themselves from risk, while speculators purposely assume risk in order to make a profit by predicting the trends and movements of the currencies relative to one another.

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