Asawari Farrell

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Currency futures contracts also referred to as foreign exchange futures or FX futures for short, are a type of futures contract to exchange a currency for another at a fixed exchange rate on a specific date in the future.

Since the value of the contract is based on the underlying currency exchange rate, currency futures are considered a financial derivative. These futures are very similar to currency forwards however futures contracts are standardized and traded on centralized exchanges rather than customized.

Currency futures are standardized contracts that trade on centralized exchanges. The futures are either cash-settled or physically delivered. Cash-settled futures are settled daily on a mark-to-market basis.

As the daily price changes, the differences are settled in cash until the expiration date. For futures settled by physical delivery, at the expiration date, the currencies must be exchanged for the amount indicated by the size of the contract.

Foreign exchange futures contracts comprise several components outlined below:

Since currency futures are traded on centralized exchanges and through clearinghouses, and margins are put into place, this vastly reduces counterparty risk compared to currency forwards. A typical initial margin can be around 4% and a maintenance margin around 2%.

Like other futures, foreign exchange futures can be used for hedging or speculative purposes. A party who knows they will need a foreign currency at a future point, however, does not want to purchase the foreign currency at this point in time may buy FX futures. This will act as a hedged position against any volatility in the exchange rate. At the expiration date when they need to buy the currency, they will be guaranteed the FX futures contract’s exchange rate.

Similarly, if a party knows that they will receive a cash flow in the future in a foreign currency, they can use futures to hedge this position. For example, if a company in the US is doing business with a country in Germany, and they are selling a large item payable in euros in a year, the US company may purchase currency futures to protect against negative swings in the exchange rate.

Currency futures are also often used by speculators. If a trader expects a currency to appreciate against another, they can buy FX futures contracts to try to gain from the shifting exchange rate. These contracts can also be useful for speculators because the initial margin that is held will generally be a fraction of the size of the contract. This allows them to essentially lever up their position and have more exposure to the exchange rate.

Currency futures can also be used as a check for interest rate parity. If interest rate parity does not hold, a trader may be able to employ an arbitrage strategy to profit purely from borrowed funds and the use of futures contracts.

Investors looking to hedge a position often use currency forwards due to the ability to customize these over-the-counter contracts. Speculators often use currency futures due to the high liquidity and ability to leverage their position.

Let us now look at an example that involves currency futures. Say you purchase 8 future Euro contracts (€125,000 per contract) at 0.89 US$/€.  At the end of the day, the settlement price has moved to 0.91 US$/€. How much have you lost or profited?

The price has increased meaning you have profited. The calculation to determine how much you have profited is as follows:

(0.91 US$/€ – 0.89 US$/€) x €125,000 x 8 = 20,000 US$

Thank you for reading CFI’s article on currency futures. If you would like to learn about related concepts, check out CFI’s other resources:

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