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Currency Futures Pricing

In trading currency futures, we need to understand how these contracts differ in their pricing to those in the spot fx market, so that when we are moving between the two markets, or perhaps hedging the spot market with a futures contract, we compare apples with apples, and not pears! The two operate very differently for reasons which I will explain.

The principle difference between the way currency futures pricing works, and contracts in the spot fx markets, lies in the way the interest rate differential of the country concerned is paid for, during the life of the contract. In a  spot trade the exchange of currency normally takes place 2 days after the initial order has been placed. A futures contract however may settle in 3 months time, on a quarterly contract. In order to derive futures rates for these specific contracts, traders use a combination of spot rates plus or minus ‘forward points’ to obtain the futures rates. In simple terms forward points are simply points that represent the interest rate differential between the two countries. These forward points express the benefit or disadvantage of holding the currency for a specific period of time, in just the same way that we view a carry trade in the spot market – either positive or negative in the interest it pays. The difference here is that with the futures contract this element of positive or negative interest has to be built into the price quoted for the contract – let me give you a live example which I have taken as a screen shot from the CME exchange live data:

CME - Euro FX Currency Futures Contract

CME - Euro FX Currency Futures Contract

Now the screen shot to the left is  kindly provided by the Chicago Mercantile Exchange from their new live data feed for currency futures. Two things you will notice straight away. Firstly that the exchange provides simultaneous live prices for both currency futures and spot prices, which is excellent if you are trading or hedging between markets, and secondly that you notice the “forward point” I mentioned above. As you can see if we look at the Euro FX which is the first contract, the spot rate is 1.4614, but the future rate immediately above is shown as 1.4598 – 1.4599. The difference between them is the forward points, shown in the box below – in this case 16-15.50. This represents the interest accrued or to be paid for the remainder of the contract. If you held this contract to expiry then on settlement day the spot and futures prices would be the same. The forward point element unwinds on a linear basis over the lifetime of the contract. Now one of the difficulties when comparing the currency futures with their equivalent spot prices is that the two markets use different quote conventions, which can be very confusing for the newcomer. As spot traders we are all familiar with the pair conventions that are used such as GBP/USD, EUR/USD and USD/JPY. Well in the futures convention, where all currencies are based against the US dollar, the quotes are presented differently, as the currency is quoted in terms of US dollars per unit of the other currency being traded.

In order to compare futures prices with spot prices, we therefore have to invert the currency pair to arrive at the futures prices. So if we take the USD/JPY which becomes the JPY/USD then the spot market price is 106.54, and the futures contract price is 1/106.54=9383, plus the forward points of 31 which give us 9414 ( see in the above example ). The CME have recently introduced the above live system which is free, so I would urge you to use it, particularly if you are a little confused by the way currency futures pricing works. Now finally let’s look at a couple of simple examples of how we work out our profit and loss on the futures trades.

In order to calculate our profit or loss on a contract it is vital that we have the following information as follows :

  • The contract size – this is the number of currency units being traded and also called trade unit – for the Euro above, the contract size is 125,000. ( remember that e-mini contract sizes will be different)
  • Tick value – the tick value is the smallest trading increment for the contract. Tick values vary among various currency futures contracts so please make sure you know beforehand ( if in doubt ask, but these will always be shown by the exchange in their ‘specification’ sheet. ) For the Euro shown above the tick value is 0.0001

So is we buy a Euro FX futures contract at 1.4607, and sell some time later at 1.4615, then our profit ( in US dollars)  is as follows :

  • 1.4615 – 1.4607 * 125,000 *0.0001 = $100

In other words each tick price movement represents a $12.50 increase or decrease in the value of our futures contract. Equally had we bought 5 contracts then our profit would have been $500. As with the spot market it is just as easy to sell short, in this case we sell a contract to open if we believe prices will fall, and buy to close. Had we sold a contract at 1.4615 and the price had fallen and we then bought to close our position at 1.4602, then our profit would be :

  • 1.4615 – 1.4602 * 125,000 *0.0001 = $162.50

OK – I hope that’s explained some of the currency futures pricing and contract variations between the spot and futures markets in currency.