Currency futures are a trading instrument in which the underlying asset is a currency exchange rate, such as the euro to US Dollar exchange rate, or the British Pound to US Dollar exchange rate. Currency futures are essentially the same as all other futures markets (index and commodity futures markets) and are traded in the same manner.
Futures based upon currencies are similar to the actual currency markets (often known as Forex), but there are some significant differences. For example, currency futures are traded via exchanges, such as the CME (Chicago Mercantile Exchange); currency markets are traded via currency brokers and are therefore not as regulated as currency futures.
There are some day traders who prefer the currency markets while others prefer currency futures. If you are considering trading in the currency futures, you should understand what they are based on, how transactions work, what margins are, and know some of the popular futures.
Currency Futures Background
Currency futures are based on the exchange rates of two different currencies. For example, the euro and the dollar (EUR/USD) is a pair of currencies that have an exchange rate. The controlling currency is the first currency listed in the pair—in this case, it is the euro price that futures traders are concerned with. Traders buy a contract worth a set amount, and the value of the contract goes up or down with the value of the euro.
Currency futures only trade in one contract size, so traders must trade in multiples of that. As an example, buying a Euro FX contract means the trader is effectively holding $125,000 worth of euros.
Since markets move in ticks, each tick is worth a certain amount of money for each type of investment and market. The Euro FX market moves in tick sizes of .00005 dollars per euro, or price movements of $6.25 ($125,000 X .0005). In other words, you purchase one Euro FX contract for $125,000, and the value then moves up or down a certain number of ticks per day. If the change in price for the day was $.0051 per euro, you would have made $637.50.
In the forex market, a trader can trade in multiples of $1000, which allows them to fine-tune their position size to a much greater degree. One market isn't better than another, but one may suit a trader (and their account size) better than the other.
Settlement, Delivery, and Profits
Currency futures are based on the exchange rate of a currency pair and are settled in cash in the underlying currency. For example, the EUR futures market is based upon the euro to dollar exchange rate and has the euro as its underlying currency.
Settlement and delivery occurs when a EUR/USD futures contract expires—the holder receives delivery of $125,000 worth of euros in cash to their brokerage account.
Note that this only happens when the contract expires. Day traders do not usually hold futures contracts until they expire. Therefore, they should not be involved in the settlement, and will not receive delivery of the underlying currency.
Day traders, or anyone who is trading currency futures for speculation and profit, reap rewards based on the price difference between purchase and sale price. With futures, you can also sell first and then buy later, collecting a profit if the price drops.
To determine the profit made on a currency pair, you first calculate the expiration amount and the tick values for the entry and exit amount.
For example, assume a trader buys a Euro FX contract at 1.2525 and then sells it at 1.2545. That is a 20 tick profit, and each tick in that contract is worth $12.50. Therefore, the profit is $12.50 x 20, multiplied by the number of contracts the trader had bought.
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