Question on Futures
Hi all, I had a question regarding futures (a very basic one, but I am new to trading:
Does a futures contract work both ways?
Meaning, if I have a futures contract for a currency and use it, can I then change it back?
Let me give an example of what I mean:
I have 1000 pounds and I think the pound is going to get stronger with respect to the euro.
Let's say the current exchange rate is 1GBP=1.20Euros
I change all of my money into euros (so I have 1200 euros) and I sign a future contract with a change of 1.20Euros
The pound price now rises to 1GBP=1.25Euros
So I use my future contract and change back from 1200 euros to 1000 pounds, and then change back at the current market rate and get 1250 euros
Can I then use my future contract again to have 1250/1.2 = 1041.67 pounds?
Is that how futures work with currencies?
Thanks!
Futures contracts don't really have strikes...
In your example, if you have bought the GBPEUR futures at 1.20 and the current mkt price is 1.25, you could liquidate your position. This should produce some profit, which should give you the same result that you're seeking (absent any slippages).
Thank you for your reply. Sorry for the question, but what does 'liquidate your position' mean exactly? To sell it? How does the process work? (As in, how do you put a value to the position and so on) Thanks! I've edited the 'strike' price. As said, still learning.
Assuming you bought the futures, liquidating would involve selling, and vice versa.
The "value" of the position is given by the mkt price, or more accurately said, the cumulative profit on your futures trade is determined by the difference between the price you originally traded at and the price at which you can liquidate).
You seem to be misunderstanding the difference between a futures contract, a forward contract and the spot market.
They are all similar, but at the same time, very different.
The spot market is just that...trading things for immediate settlement (delivery) "on the spot". After a spot transaction has been "done" and settlement has occurred, the transaction is over.
So, if you take your 1000 GPB, and you use the spot market price of GBP/EUR @1.20 to convert that into 1200 EUR, you no longer have 1000 GBP...you now have, in your pocket, 1200 EUR. You can think of this just like buying for something at the store. In this case, you bought 1200 EUR...and the price was 1000 GBP. You walked into the store with 1000 GBP in your pocket...you used that 1000 GBP to buy 1200 EUR...and the you walked out with that 1200 EUR in your pocket..leaving the 1000 GBP with the shopkeeper. This trade/purchase is done and over. You don't have 1000 GBP anymore..you just have 1200 EUR.
If the GBP/EUR FX rate goes from 1.20 --> 1.25.....then if you had NOT converted your GBP into EUR, then you would be able to convert your original 1000 GBP into 1250 EUR (EUR on sale cuz they are cheaper now). BUT!!! you already converted your 1000 GBP into 1200 EUR....so you lost out on this particular transaction (you converted/bought EUR too soon!!!)
If you then convert your 1200 EUR back to GBP at the new rate of 1.25, you will end up with 960 GBP (1200 EUR / 1.25 fx rate = 960)
1.20 is the rate to go from GBP to EUR To go the other way (from EUR to GBP) you have to invert the GBP/EUR fx rate (1/1.25) = 0.8 0.8* 1200 EUR = 960
So, now you understand how the fx spot market works.
A forward contract is: a contract directly between 2 parties, agreeing on a specific quantity of something, to be delivered from the seller directly to the buyer, on a specific date in the future, at a specific price, at the settlement date of the contract. Forward contracts are not necessarily standardized...you can enter into a forward contract with anybody, for any quantity, for delivery and settlement at any time, at any price (assuming both parties agree to all the terms of the contract).
Forward contracts are very much like the spot market described above...except that settlement takes place at a date specified in the future, as defined by the forward contract, instead of immediately.
A Futures contract however is different: a financial trading instrument, standardized and traded at an official exchange, with terms set by the exchange. Every futures contract has its own specific set of terms that are defined by the exchange where they are traded. When trading (taking a long or short position) in a futures contract, traders are actually taking a position against the exchange, instead of directly with a counterparty on the other side of the trade. So, the exchange acts as a middleman between the longs and shorts, and is compensated for providing this service (exchange fees).
Lets talk about both legging, and directly trading a cross fx pair.
There is a GBP/USD and EUR/USD futures contract (6B and 6E). So, lets look at the 6B contract...the current price is 1.3300 (thats the GBP/USD fx rate). There is also a EUR/GPB futures contract (RP) which last marked @ 0.84.
The 6B futures contract only trades in increments of 62,500 GBP (1 futures contract is a position in 62,500 GBP)
If you "go long" 1 6B contract @ 1.3300, and then the price moves 1pip in your favor (1.3301) 0.0001 * 62500 = 6.25
Since the CME is in chicago, this PnL is done is USD....so that's $6.25
Since you want GBP/EUR exposure, you would also take a position in 6E (EUR/USD). These 2 legs (6B and 6E) should simulate a position in RP (EUR/GBP)
The 6e contract is based on 125,000 EUR (so, not the same units as the 6B futures contract...so this would not give you an exact GBP/EUR exposure unless you figure out the correct hedge ratio of contracts to use).
Some brokers offer FX pairs trading in a margin account, which is similar to a futures contract, but not exactly. In an FX margin trading account, your broker will allow you to borrow one currency, and then use that borrowed currency to purchase a different currency (this is standard fx pairs trading). The margin required to borrow the first currency differs from broker to broker, but tends to be between 50-200x leverage.
In this case, you borrow GBP, and use it to buy EUR at the 1.20 fx rate. While this position is open, you must pay a daily interest rate for the GBP cash that you are borrowing. However, you will also receive a daily interest rate on the EUR that you are now holding. Depending on the currencies involved, these interest rates may wash with a net result of zero interest...but this is something that you need to check.
Regardless, when you reverse this trade by selling EUR to buy GBP to close out your position...if the GBP/EUR fx rate has moved from 1.20 --> 1.25, you will still realize the same loss of 40 GBP on the initial 1000 GBP position (plus transaction and financing costs).
Thank you for your long and detailed response. It is great. Okay, let's put it this way and perhaps you can explain to me what would be the way to go. I have 1000 pounds, and I think the currency is going to get stronger with respect to the euro. How do I make money?
if you own something that you think will go up in value...you just hold on to it until it actually DOES go up in value...and then AFTER it goes up in value, you sell it.
Conversely, if you want to BET that something will go up in value vs something else, then you put on a pairs trade. You buy more of the thing that you think will go up, funding that purchase via borrowing (shorting) the thing you think will be relatively lower in value (lower price).
So in this example, go long GBP/EUR fx pair...or short the EUR/GB pair...remember that the order that you quote the fx pairs matters. However, if you go into an FX pairs position, you have leveraged exposure both ways...if the position moves against you, you can theoretically lose everything.
Or, you can use futures contracts (short 6E vs long 6B) but that creates a larger position that you are looking to have, as you have written it. I think there actually is a EUR/GBP futures contract (ticker symbol RP, based on 125,000 EUR). Taking a position (long or short) in just 1 of these futures contracts is the equiv of taking a position with 125,000 EUR. (i think you need ~ $4000 margin, at a minimum per futures contract...so this gives you about 25x leverage...FX pairs trading brokers will give you 50-100x leverage).
So, if you were to short 1 RP contract (EUR/GBP) @ the current price of 0.8428, your PnL would go up 12.50 GBP for every pip (6.25 for every half pip).
1 "pip" is going from 0.8428 --> 0.8429 (inverted that's like going from 1.1865 --> 1.1864 for GBP/EUR)
However, recall that these futures contracts are like taking a position in 125,000 EUR worth of the fx pair. Your 1000 pounds is waaaaay to small to use for these contracts....and i think FX pairs trading minimum increments is 1000 units of currency, so you might be able to trade 1 unit of the EUR/GBP fx pair...but check with your FX broker.
i would suggest looking at TD Ameritrade or FXCM if you are in the US.
https://www.tdameritrade.com/education/account-types-and-investment-pro… https://www.fxcm.com/forex/margin-requirements/
if you are outside the US, then look for an FX broker with local operations.
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