Currency Derivatives Guide
What are Futures?
In finance, a futures contract (futures) is a standardised contract between two parties to buy or sell a specified asset of standardised quantity and quality for a price agreed upon today (the futures price) with delivery and payment occurring at a specified future date. The contracts are negotiated on a futures exchange, which acts as an intermediary between the two parties.
What are Options?
In finance, an option is a contract which gives the buyer (the owner) the right, but not the obligation, to buy or sell an underlying asset or instrument at a specified strike price on or before a specified date. The strike price (or exercise price) of an option is the fixed price at which the owner of the option can buy (in the case of a call) or sell (in the case of a put) the underlying security or commodity). The seller incurs a corresponding obligation to fulfil the transaction – that is to buy or sell – if the owner elects to "exercise" the option prior to expiration. The buyer pays a premium to the seller for this right. An option which conveys to the owner the right to buy something at a specific price, is a call; an option which conveys the right of the owner to sell something at a specific price, is a put.
What are Currency Futures?
Currency Futures are derivative contracts that are traded on the JSE’s YieldX Exchange -they allow the investor to trade an exchange rate at some specified date in the future.
An investor that buys a Dollar and sells a Rand at R9.00 is going long of the currency future - he wants the Dollar to appreciate and therefore wants the Rand to go from R9.00 to R9.50.
An investor that sells a Dollar and buys a Rand at R9.00 is going short of the currency future, wants the Dollar to depreciate, and therefore wants the rand to go from R9.00 to R8.50.
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Why trade Currency Futures?
Currency future contracts allow investors to hedge against foreign exchange risk or currency risk.
Companies whose business processes entail receiving/settling transactions in a foreign currency can use this instrument to lock in a specific rate.
Currency future contracts allow investors to speculate on the future movements of the exchange rates.
What is the difference between spot, forward and futures rate?
Spot: Is today’s exchange rate for the physical exchange of currencies.
Forward: The forward rate is a fixed price based on a future date’s rate as stipulated in a private agreement. These private agreements are not as rigid in their terms and conditions as exchange traded contracts.
Futures
:
Fundamentally, forward and futures contracts have the same function: both types of contracts allow people to buy or sell a specific type of asset at a specific time at a given price.However, it is in the specific details that these contracts differ. First, futures contracts are exchange-traded and, therefore, are standardized contracts. Because forward contracts are private agreements, there is always a chance that a party may default on its side of the agreement. Futures contracts have clearing houses that guarantee the transactions.
Secondly, the specific details concerning settlement and delivery are quite distinct. For forward contracts, settlement for forward contracts occurs at the end of the contract. Futures contracts are mark-to-market daily, which means that daily changes are settled day by day until the end of the contract. Furthermore, settlement for futures contracts can occur over a range of dates. Forward contracts, on the other hand, only have one fixed settlement date.
Lastly, speculators who bet on the direction in which an asset’s price will move, frequently use futures contracts. Usually futures contracts are closed out prior to maturity and delivery usually never occurs. On the other hand, forward contracts are mostly used by hedgers that want to eliminate the volatility of an asset's price, and delivery of the asset or cash settlement will usually take place.
There are four categories of participants in the currency derivatives market:
Hedgers use currency futures or options to protect against possible adverse currency movements and foreign exchange risk. Hedgers therefore seek to reduce risk. Hedgers have a real interest in the underlying currency and use futures or options as a way of preserving their performance.
Arbitrageurs profit from price differentials of similar products in different markets, e.g. price differentials between the spot exchange rate and futures or options price.
Investors use currency futures or options to enhance the long-term performance of a portfolio of assets.
Currency Futures quotes
Yield-X quotes all currency futures prices in the same way as the underlying spot rate, quoted to four decimal places. A currency quote is always against a base currency followed by the quoted currency. The reason all currencies are quoted in pairs is that in every foreign exchange transaction, you are simultaneously buying one currency and selling another.
Here is an example of a foreign exchange rate for the US dollar versus the South African rand.
Example: The quote in the sample shows the US Dollar as the base currency and the Rand as the quoted currency. The terminology used is “the Rand is trading at R10.0534 against the US Dollar”. This sample shows that you need R10.0534 Rand to purchase $1 US Dollar, and this is the exchange rate, i.e. to exchange R10.0534 for $1US Dollar.
If you want to buy (which means buy the base currency and sell the quote currency), you want the base currency to increase. This is “going long” or taking a “long position”: Long = Buy
If you want to sell (which actually means sell the base currency and buy the quote currency), you want the base currency to decrease. This is “going short” or taking a “short position”. Short = sell
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Bid / Ask
All forex quotes are quoted with two prices: the bid and ask.
Bid: is the price at which you are willing to buy the base currency in exchange for the quote currency. This means the bid is the best available price at which you (the trader) will sell to the market.
Ask: is the price at which you are willing to sell the base currency in exchange for the quote currency. *Another word for Ask is the offer price
Ask price: is the best available price at which you will buy from the market. Spread: the difference between the bid and the ask price is known as the spread.
*As viewed on the Swordfish platform
On the September 2013 contract USD/ZAR quote above, the bid is at R9.7365 and ask is at R9.7397 Bid: If you want to sell rand (in other words you expect the rand to weaken against the dollar), then you click “Bid” to go long at R9.7397.
Ask: If you want to buy rand (in other words you expect the rand to strengthen against the dollar), then you click "Sell" to go short at R9.7365.
Example: The US Dollar / Rand was trading at R10.00 yesterday and today it is trading at R10.30 - this means that the base currency which is the US Dollar (left in the equation), increased or strengthened from R10.00 to R10.30 and the quoted currency which is the Rand (right in the equation), decreased or weakened from R10.000 to R10.30. Therefore, in this example we can say that the Rand weakened against the dollar, which is good news for exporters because they get more Rands for their goods, while importers have to pay more.
In the reverse example the US Dollar / Rand was trading at R10.30 yesterday and today it is trading at R10.00 - this means that the base currency which is the US Dollar (left in the equation), decreased or weakened from R10.30 to R10.00 and the quoted currency which is the Rand (right in the equation), increased or strengthened from R10.30 to R10.00. Therefore, in this example we can say that the Rand strengthened against the Dollar, which is good news for importers because they pay less Rands for their goods, while exporters get less money for their goods.
Expiry months and date
The currency futures and options contracts expire two business days before the third Wednesday of each expiry month. In the months where this day is not a business day, the contract will expire the first business day before the allocated day.
• March • June • September • December Settlement
The foreign currency futures contracts are cash settled in Rand. In other words, no physical delivery of the underlying currency or base currency will ever take place.
Margins
The Mark-to-Market (MTM) process entails calculating the price movement from the close of yesterday to the close of today. The difference in the closing prices determines the profit or loss of the position. If the difference is positive then the profit is paid to the investor. If the difference is negative then the investor has to pay the JSE clearing house the amount owed.
Closing out or rolling over a Position
Currency Future contracts can be bought or sold, any time during the JSE YieldX Exchange hours: 09H00 - 17H00 during workdays, or left to expire on the date the contract ends or rolled over to the next contract month.
Closing out a contract entails the investor taking an equal and opposite position to his existing position. For example, if an investor has entered a long position i.e. buys 1 contract in the Currency Futures contract he would need to sell 1 contract. The net of the two positions will be zero thus closing out the initial contract position.
The futures contract can also be rolled over. This means that the investor can choose to keep the same position past the expiry date of the contract, that is: he can roll the position over to the next expiry date. The exchange offers a discounted fee for all positions that are rolled over. The investor benefits from rolling his position over because the same hedge is preserved. Options contracts can’t be rolled over and they expire at the end of their duration.
Alternatively, the investor can let the contract automatically expire on the date of expiry. Here, the exchange closes out the position and charges a fee for doing so. On the expiry day the contract position is Mark-to-Marketed for the last time and the initial margin is returned.
Yield-X offers the following currency futures contracts:
Symbol
Country
Currency
ZAR
South Africa
Rand
EUR
Euro zone members
Euro
JPY
Japan
Yen
GBP
Great Britain
Pound (Sterling)
CHF
Swiss Franc
Franc
AUD
Australia
Dollar
CAD
Canada
Dolar
Benefits of trading currency futures via the Yield-X exchange Currency futures equalise the playing field for all investors
The product allows for individuals to access the currency market generally reserved for institutions and allows for smaller corporate entities to access favourable rates generally reserved for the larger corporates
The Johannesburg Securities Exchange regulates transactions Allows for transparent pricing
Less administration - no reporting to SARB required and no firm and ascertainable commitment required (i.e. no SARB documentation required to hedge: only a YieldX Client Agreement and FICA) No penalties for adjusting your position excluding basic cost
Low brokerage
Low margin requirements Daily summary and research
Low barriers to entry – online software platform available i.e. Swordfish
High liquidity - you can instantaneously buy and sell at will as there will usually be someone in the market willing to take the other side of your trade
Leverage - a small deposit can control a much larger total contract value. Leverage gives the trader the ability to make nice profits, and at the same time keep risk capital to a minimum.
Currency Futures Details
Contract size: 1 futures contract exposes you to 1000 of the foreign underlying currency or the base currency: US$ 1000 or €1000 or £1000
Price movement: 1c = R10 Profit or Loss per contract
Contracts quoted to 4 decimal places – in the currency markets one unit is called a ‘tick’ or a ‘pip’ and it refers to the minimum price movement, i.e. 0.0001 to 0.0002 = 1 tick or pip movement
Price movement from R9.0535 to R9.0536 = 1 tick = R0.10 per contract
Price movement from R9.0535 to R9.0635 =1c = R10 per contract (1c = 100 ticks) Price movement from R9.05 to R9.06 = 1c = R10 per contract
Cash settlement in Rand
No physical delivery of foreign currency
Example: If you buy 1 US Dollar / Rand contract at R10.00 and you sell your 1 contract at R10.30 to close-out the position (the base currency increases or strengthens while the quoted currency decreases or weakens) then you have made a profit minus the brokerage and exchange fees.
R10.30 – R10.00 = 30c price movement. Therefore, 0.30*1000 (contract size)*1 contract = R300 profit. If you bought 2 contracts then the equation is, 0.30*1000*2 contracts = R600 profit. This example only shows the gross profit.
The net profit equals gross profit minus brokerage and exchange fees:
Total costs (brokerage and exchange fees) are R12.50 per contract or 0.1250c price movement per contract.
Examples: Hedging a transaction for importers Currency Future example 1.
How to place an order:
John believes the Rand will weaken against the US Dollar, but is not sure how to benefit from this. John calls his
broker and explains his views. His broker advises John to buy (go long) a future on the US$/R contract (enabling John
to buy $ and sell Rand), or to buy a call option.
Currency Future example 2.
R 1,000
Day 1
Day 2
Day 3
Day 20
Buy @ 10.0000
10.0000
Market to Market Price
10.2820
10.1000
10.1500
10.3000
Profit/Loss for the day
0.2820
-0.1820
0.0500
0.1500
Multiplier
1000
1000
1000
1000
Profit/Loss * Multiplier
282
-182
50
150
Initial margin per contract
R
400
0
0
R
400
Brokerage including JSE fees
R
12.50
0
0
R
12.50
Nett Cashflow for the day
R
-130.50
R
-182.00
R
50.00
R
537.50
Portfolio Value
R
1,269.50
R
1,087.50
R
1,137.50
R
1,275.00
Importers risk is Rand weakness : R10.00 to R10.30 equal rand weakness. Hedge by buying the future
@ 10.00, therefore you buy the US$ and sell the Rand
Hedge or protection was entered at R10.00 and the hedge was closed at R10.30 which made R0.30 or
R275, which offsets the loss made in the spot market.
R 1,000
Day 1
Day 2
Day 3
Day 20
Buy @ 10.0000
10.0000
Market to Market Price
10.2820
10.1000
10.1500
9.8000
Profit/Loss for the day
0.2820
-0.1820
0.0500
-0.3500
Multiplier
1000
1000
1000
1000
Profit/Loss * Multiplier
282
-182
50
-350
Currency Option example
Examples: Hedging a transaction for exporters Currency Future example 1.
How to place an order:
John believes the Rand will strengthen against the US Dollar, but is not sure how to benefit from this. John calls his
broker and explains his views. His broker advises John to sell (go short) a future on the US$/R contract (enabling John
to sell $ and buy Rand), or to buy a put option.
Buy At The Money call strike @ 10.00
R 1,000
Day 1
Day 2
Day 3
Day 90
Spot @
10.0000
Premium
0.1000
Market to Market Price
0.0950
0.1100
0.0900
0.2900
Profit/Loss for the day
-0.0050
0.0150
-0.0200
0.2000
Multiplier
1000
1000
1000
1000
Profit/Loss * Multiplier
-5
15
-20
200
Initial margin per contract
R
100
0
0
R
100
Brokerage including JSE fees
R
12.50
0
0
R
-Nett Cashflow
R
-117.50
R
15.00
R
-20.00
R
300.00
Portfolio Value
R
982.50
R
997.50
R
977.50
R
1,177.50
The call option was entered at strike R10.00 and the option expired at 10.30 in the money i.e made a
profit of R117.50.
R 1,000
Day 1
Day 2
Day 3
Day 20
Sell @ 10.3000
10.3000
Market to Market Price
10.2820
10.1000
10.1500
10.0000
Profit/Loss for the day
0.0180
0.1820
-0.0500
0.1500
Multiplier
1000
1000
1000
1000
Profit/Loss * Multiplier
18
182
-50
150
Initial margin per contract
R
400
0
0
R
400
Brokerage including JSE fees
R
12.50
0
0
R
12.50
Nett Cashflow for the day
R
-394.50
R
182.00
R
-50.00
R
537.50
Portfolio Value
R
1,005.50
R
1,187.50
R
1,137.50
R
1,275.00
Hedge or protection was entered at R10.30 and the hedge was closed at R10.00 which made R0.30,
which offsets the loss made in the spot market.
Currency Future example 2.
Currency Option example
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