Currency futures trade in a completely different manner than the cash foreign exchange market where trading is done primarily in the spot and forward markets over an electronic and telephone network.
The currency futures market has grown considerably since their introduction on the International Monetary Market division of the Chicago Mercantile Exchange in the early 1970s.
Before the rise of online retail forex trading in recent years, trading currency futures on the Chicago IMM was one of the few ways that individuals could trade currencies in smaller amounts.
Nevertheless, futures trading accounts for only 7% of the total forex daily volume, which is still an impressive number at $210 billion per day.
What is a Futures Contract?
A currency futures contract consists of a standardized agreement to make the delivery of one currency and receive another currency at some fixed upcoming point in time at a rate determined by the market.
Put simply, a currency futures contract is a forex forward contract with a standard delivery date and standard contract sizes traded on a centralized exchange.
Key Differences Between Currency Futures and Spot Trades
Unlike a regular spot forex transaction, where the delivery date typically occurs two business days from the transaction date, currency futures contracts on the IMM have quarterly delivery dates occurring on the third Wednesday of the month.
For example, a British Pound Sterling versus the U.S. Dollar or GBP/USD futures contract would be deliverable in the months of March, June, September and December. Each GBP/USD futures contract would involve a transaction amount of 62,500 British Pounds each.
Also, since the exchange where the futures contracts trade is in the United States, the contracts are bought and sold in U.S. Dollars. This means that futures prices for currency pairs like EUR/USD, GBP/USD, AUD/USD, NZD/USD are quoted the same way as in the forex spot market, but rates for pairs like USD/JPY, USD/CAD and USD/CHF are inverted.
How Currency Futures Are Traded
Trading in currency futures was initiated by the International Monetary Market which began in 1972 on the floor of the Chicago Mercantile Exchange.
These futures became popular with commodities traders as a way to speculate on exchange rate movements. The futures concept is also very familiar to commodities traders since they are used to a farmer selling a crop before a harvest, for example.
With currency futures, a whole new world opened up which allowed for smaller traders to effectively trade the forex market without having to trade through a bank, which often looked down on personal traders dealing in smaller sizes or simply refused to quote them.
Watching currency futures trade on the floor of an exchange can be a confusing endeavor. The first thing that comes to mind is a pack of wild animals howling and making gestures at each other.
The chaos is superficial at best, since virtually everything happening in the trading pit is carefully orchestrated to provide instantaneous executions and fair prices for both the local traders and for off the floor traders.
Currency Futures Versus Forex Trading
Besides delivery dates and quotation conventions, a number of additional differences exist between currency futures trading and forex trading.
For example, the leverage allowed with currency futures is 5:1 or 20% of the amount of the value of the futures contract. In contrast, the leverage on some retail forex accounts can be as high as 500:1 or 100 times the leverage on a futures contract. For U.S. traders the maximum leverage allowed is %0:1 for the majors and 20:1 for the minors.
Furthermore, although the markets two generally value currencies in a similar way, small pricing differences can occur between the cash and futures markets. As a result, some currency arbitrage traders even trade one market against the other by spreading transactions in the forward and spot markets against offsetting positions in the currency futures market.
Another major difference is that contracts are for minimum specified amounts or lot sizes. For example, the IMM GBP/USD futures contract is for 62,500 pounds, while the IMM’s USD/JPY contract is for 12,500,000 Yen.
This can make transactions for precise, specified amounts harder to execute. Also, the need to obtain an account with a registered commodity broker might also be more involved than opening a retail forex account that seems relatively easy to do online these days.
The last consideration is that the futures contracts must trade like a forward for the delivery date, rather than a spot trade. This means that the interest rate differentials must be determined and factored into the price for a market maker to provide an accurate quote on a futures contract.