Forex futures contracts, also known as currency futures, are a type of agreement in which the contract holder plans to buy or sell a specific amount of a particular currency at a designated date in the future. Futures are signed with a specific termination date listed, at which time the trade must be conducted unless another trade is made to offset the position. As a financial investment instrument, futures serve two main purposes – to minimize risk by hedging positions, and to speculate and profit from exchange rate fluctuations. They are known as a derivative because they derive their intrinsic value from the conditions surrounding the currency contract.
To hedge positions using forex futures contracts, dealers will take out a contract that is contrary to a specific spot trade. For example, if a someone plans on purchasing the USD/CHF pair, they could insure their investment somewhat by taking out a futures contract on CHF using USD. Thus, regardless of which way the trade goes, they have an opportunity to profit or at least retain their investment. The following information describes how to use futures to your benefits, as well as several other tactics used to accomplish similar results.
How to Use Forex Futures
Taking out a futures contract is a great way to provide insurance for spot trades( they are made in real time based on current market conditions), because they give you the opportunity to conduct a deal that is contrary to your spot trade if the exchange rate fluctuates out of favor. The futures trade will negate the loss caused by the bad spot trade, allowing you to recuperate your funds or possibly earn a profit. When using futures it is imperative to compare the spreads between the currencies, and look for the lower spreads. A spread, also known as a PIP spread, is the difference in PIPs between two currency rates. A general rule of thumb is - the lower the spread, the lower the risk. It is also important to consider interest rates and contract terms when agreeing to a contract, and you should never opt for one of these contracts if you are not in full understanding of the details.
Utilizing Forex Swaps
Forex swaps are another type derivative in which two parties agree to exchange a designated amount of a certain currency for another, and then swap back the currencies after a set period of time. This collaborative investment strategy is commonly used by international companies that need access to a particular currency and would also like to invest. In a sense, swaps are mutual investments and hedging strategies, and are typically beneficial for both parties. None of the most attractive aspects of the forex swap is the fact that the contract is negotiable for up to ten years after the closing, making ti possible for both parties to make agreed upon changes the event of significant market changes. Forex swaps are often combined with interest rate swaps to improve profitability, especially European nations where many company utilize this strategy as an investment technique.
Utilizing Forex Options
Forex options are perhaps the most popular type of derivatives used in hedging. An option is a type of contract that gives you the right to buy or deal a specific currency within a specified period of time, although you are not required to do so. The cost of a forex options contract is known as the premium, the selling price of the currency listed in the contract is called the strike price, and the date by which the trade must be conducted is called the expiration date. There are two main types of options – put option and call options. Put options give the dealer the right to sell, whereas call options give the trader the right to buy. The intrinsic value of an option is calculated by determining the difference between the strike price and the current price, which is also referred to as the spot price.
The above information should help anyone minimize their risks when trading in the forex market. Forex swaps, options, and futures are perhaps the three most common methods used to hedge investments, providing a backup plan in the event of a bad deal.