What Are Currency Futures How They Work in Trade and Investing

Ariel Courage, a seasoned editor, researcher, and former fact-checker, has extensive experience in editing and fact-checking for leading finance publications such as The Motley Fool and Passport to Wall Street.

Currency futures are exchange-traded futures contracts that specify the price of one currency in terms of another currency at a future date. These contracts are legally binding, and parties holding them on the expiration date must deliver the specified currency amount at the agreed price and delivery date. Currency futures serve various purposes, including hedging trades and currency risks, as well as speculating on price movements.

Currency futures differ from non-standardized currency forwards, which are traded over-the-counter (OTC).

Key Takeaways:

1. Currency futures are contracts that specify the price of exchanging one currency for another in the future.

2. The rate for currency futures is derived from spot rates.

3. Currency futures are used to hedge the risk of receiving payments in a foreign currency.

The Chicago Mercantile Exchange (CME) introduced the first currency futures contract in 1972 and remains the largest market for currency futures today. Currency futures contracts are marked-to-market daily, requiring traders to have sufficient capital in their accounts to cover margins and losses.

Traders can exit their obligations to buy or sell currencies before the contract’s delivery date by closing out their positions. Physical delivery of currency futures contracts occurs four times a year, except for contracts involving the Mexican Peso and South African Rand.

For instance, purchasing a Euro FX future on the U.S. exchange at 1.20 implies an agreement to buy euros at $1.20 USD. If the contract expires, the buyer must purchase 125,000 euros at $1.20 USD. On the other hand, the seller must deliver the euros and receive U.S. dollars.

In the futures markets, most participants are speculators who close out their positions before the expiry date. They profit or lose money based on price changes in the futures contracts themselves.

The daily gains or losses on a futures contract are reflected in the trading account. The difference between the entry price and the current futures price, multiplied by the contract unit, determines this gain or loss. For example, if the contract drops to 1.19 or rises to 1.21, it represents a gain or loss of $1,250 on one contract, depending on the investor’s position.

Currency futures prices are determined upon initiation of the trade.

Difference Between Spot Rate and Futures Rate:

The currency spot rate refers to the current quoted rate at which a currency can be bought or sold in exchange for another currency. The two currencies involved are known as a "pair." If an investor or hedger trades at the spot rate, the exchange takes place at or shortly after the trade. Since currency forward rates are based on spot rates, currency futures tend to change as spot rates change.

When the spot rate of a currency pair increases, there is a high probability that the futures prices will also increase. Similarly, a decrease in the spot rate is likely to lead to a decrease in futures prices. However, this is not always the case, as spot rate movements may not always affect futures that expire at distant dates. Temporary or short-term spot rate movements are less likely to impact long-term prices.

Currency Futures Example:

Consider hypothetical company XYZ, which is based in the United States and heavily exposed to foreign exchange risk. The company wants to hedge against its projected receipt of 125 million euros in September. To accomplish this, they can sell futures contracts on the euros they will receive. Euro FX futures, with a contract unit of 125,000 euros, are sold because the company does not require euros. By selling the futures contracts, they can lock in a rate at which the euros can be exchanged for U.S. dollars.

Company XYZ sells 1,000 futures contracts on the euro to hedge its projected receipt. Consequently, if the euro depreciates against the U.S. dollar, the company’s projected receipt is protected. However, selling the contracts means forfeiting any benefits that would occur if the euro appreciates. The company would still be forced to sell euros at the futures contract price, giving up any gains they could have made.

Currency futures contracts are traded on derivatives exchanges worldwide, including the Chicago Mercantile Exchange (CME), the Intercontinental Exchange (ICE), and Euronext exchanges.

The main difference between currency futures and forwards lies in their terms and trading methods. Futures contracts have standardized terms and are traded on exchanges, whereas forwards have customizable terms and are traded over-the-counter (OTC).

Currency futures are commonly used to lock in an exchange rate over a specific period. This is particularly useful in hedging against foreign currency fluctuations in international trade and among multinational corporations.