This document discusses futures and options contracts for foreign exchange. It begins by explaining the key differences between futures contracts and forward contracts, noting that futures are standardized contracts that are traded on organized exchanges and involve daily mark-to-market settlement. It then provides details on major currency futures markets, contract specifications, and how to read futures quotes. The document also introduces currency options, describing call and put options, and discusses currency futures options which provide exposure to futures contracts.

1. Futures Vs Forex Trading
TRADE12
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2. 2
Futures and Options on
Foreign Exchange
Chapter Objective:
• This chapter discusses exchange-traded currency futures
contracts, options contracts, and options on currency futures.
Chapter Outline
 Futures Contracts: Preliminaries
 Currency Futures Markets
 Basic Currency Futures Relationships
 Eurodollar Interest Rate Futures Contracts
 Options Contracts: Preliminaries
 Currency Options Markets
 Currency Futures Options
9
Chapter Nine

3. 3
9.1 Futures Contracts
 A futures contract is like a forward contract:
 It specifies that a certain currency will be exchanged for another at a
specified time in the future at prices specified today.
 A futures contract is different from a forward contract:
 Futures are standardized contracts trading on organized exchanges with daily
resettlement through a clearinghouse - marked to market.
 Standardizing Features: contract size, delivery month, daily
resettlement - marked to market
 Initial Margin: about 2-5 % of contract value, cash or T-bills held
in a street name at your brokers.
 Participants’ losses or profits are realized daily instead of at
maturity as with a forward contract.
 Because of marking to market, the futures price converges through
time to the spot price on the last day of trading in the contract.

4. 4
Daily Resettlement = Marking to Market
Example: On Monday morning you take a long position in SF futures
contract that matures on Wednesday afternoon at $0.75/SF.
1. At the close of trading on Monday the futures price has risen to
$0.755. Because of the daily settlement you receive a cash profit of
$625 =125,000 x (0.755-0.75)
2. At Tuesday close the price has declined to $0.743. You must pay
the $1500 loss (125,000 x [0.743-0.755]) to the other side of the
contract.
3. At Wednesday close, the price drops to $0.74, and the contract
matures. You pay $375 loss to the other side and take the delivery
of the SF, paying the prevailing price of $0.74. You have a net loss
on the contract of $1250 (625-1500-375)
You can also close out your long position with an offsetting trade, if
you don’t want the delivery of the SF.

5. 5
9.2 Currency Futures Markets
 The Chicago Mercantile Exchange (CME) is by far the largest.
 Others include:
 The Philadelphia Board of Trade (PBOT)
 The MidAmerica commodities Exchange
 The Tokyo International Financial Futures Exchange
 The London International Financial Futures Exchange
 Expiry cycle: March, June, September, December.
 Delivery date 3rd Wednesday of delivery month.
 Last trading day is the second business day preceding the
delivery day.
 CME hours 7:20 a.m. to 2:00 p.m. CST.

6. 6
Currency Futures Contract
Specifications

7. 7
Currency Futures Quotations (CME)

8. 8
9.3 Basic Currency Futures Relationships
 Open Interest refers to the number of contracts
outstanding for a particular delivery month.
 Open interest is a good proxy for demand for a
contract.
 Some refer to open interest as the depth of the
market. The breadth of the market would be how
many different contracts (expiry month, currency)
are outstanding.

9. 9
Reading a Futures Quote ($/€)
Open Hi Lo Settle Change Lifetime
High
Lifetime
Low
Open
Interest
Sept .9282 .9325 .9276 .9309 +.0027 1.2085 .8636 74,639
Expiry month
Opening price
Highest price that day
Highest and lowest
prices over the
lifetime of the
contract.
Number of open contracts
Lowest price that day
Closing price
Daily Change

10. 10
Long and Short Positions in a
Futures Contract

11. 11
9.4 Eurodollar Interest Rate
Futures Contracts
 Widely used futures contract for hedging short-term
U.S. dollar interest rate risk.
 The underlying asset is a hypothetical $1,000,000
90-day Eurodollar deposit—the contract is cash
settled.
 Traded on the CME and the Singapore International
Monetary Exchange.
 The contract trades in the March, June, September
and December cycle.

12. 12
Reading Eurodollar Futures Quotes
EURODOLLAR (CME)—$1 million; pts of 100%
Open High Low Settle Chg Yield
Settle Change
Open
Interest
June 94.71 94.75 94.65 94.68 -.01 5.32 +.01 47,417
Eurodollar futures prices are stated as an index number of three-
month LIBOR calculated as F = 100 – LIBOR.
The closing price for the July contract is 94.68 thus the implied yield
is 5.32 percent = 100 – 94.68
The change was .01 percent of $1 million representing $100 on an
annual basis. Since it is a 3-month contract one basis point
corresponds to a $25 price change.

13. 13
9.5 Currency Options-Preliminaries
 Call options gives the holder the right, but not the obligation, to buy
a given quantity of some asset in the future, at prices agreed upon
today.
 Put options: the holder has the right, but not the obligation, to sell a
given quantity of some asset in the future, at prices agreed upon
 At-the-money (ATM) E = S
The exercise price (E) equals the spot price (S) of the underlying asset.
 In-the-money (ITM) E < S
The exercise price (E) is less than the spot price (S) of the underlying asset.
 Out-of-the-money (OTM) E > S
The exercise price is more than the spot price of the underlying asset today.

14. 14
Currency Options Markets
 Originally traded OTC
 PHLX
 OTC volume is much bigger than exchange volume.
($130Bil. vs. $3Bil. Per day)
 Trading is in six major currencies against the U.S.
dollar.
 Options contract sizes are half of the futures
contracts

15. 15
PHLX Currency Option
Specifications

16. 16
Currency Futures Options
 Currency futures options are an option on a currency
futures contract.
 Exercise of a currency futures option results in a long
futures position for the holder of a call or the writer of a
put.
 Exercise of a currency futures option results in a short
futures position for the seller of a call or the buyer of a put.
 If the futures position is not offset prior to its expiration,
foreign currency will change hands.

17. 17
Call Option Value at Expiry

18. 18
Pay-off to Purchaser of a
Call Option on C$ for US$

19. 19
Pay-off to Writer of a
Call Option on C$ for US$

20. 20
Pay-off to Purchaser of a
Put Option on C$ for US$

21. 21
Pay-off to Writer of a Put Option
on C$ for US$

22. 22
Call Option Hedge for $US1m to
be Received in Three Months