Forex Investment and Currency Trading

If you wish to engage in futures transaction, various types of futures contracts are available to you based on various underlying assets and instruments.

Futures on interest rates

Interest-rate futures contracts are available on a broad range of financial instruments. The underlying asset is always an instrument which is based on the payment of interest. Contracts on money market instruments and time deposits as well as contracts on short- and long-term government securities are traded on futures and options exchanges across the globe. There are standardized interest-rate futures contracts on U.S. treasury securities, British long tilts and French OATs, among many others.

Futures on equity indices

The underlying instrument of an equity index future is an instrument which cannot actually be delivered, namely an equity market index calculated according to defined rules. Some well-known example of equity indices are the German DAX, the U.S. S&P 500, the Japanese Nikkei 225, the British FT 100 and the French CAC 40. An equity index is based on a defined basket of shares in different companies (hypothetical portfolio) and expresses the weighted market value of a large number of different shares in a single composite figure – for example, in the case of the DAX, the composite value of 30 shares. Futures contracts n such equity market indices are traded on international futures and options exchanges. Futures on equity indices are generally settled in cash.

Currency futures

The subjects of a currency futures contract is the receipt or delivery of a defined amount of foreign currency on a fixed date at a pre-agreed rate of exchange. Currency futures contracts are tradable in the major currencies, especially U.S. dollars. While exchange-traded currency futures are relatively unimportant in the European market, they enjoy a very active and liquid market in the United States on the Chicago Board of Trade (CBOT).

Possible applications

Depending on your strategy, you as an  investor may pursue a number of differing objectives using futures.

Futures may be used for hedging purposes, which means protecting against risks. Price risks related to existing or planned positions in the underlying asset (spot positions) can be largely neutralized by entering into offsetting positions in the relevant futures contract. If a loss is incurred on the spot position, a previously sold futures contract (i.e. future short position) may produce a profit of approximately the same magnitude. On the other hand, if the price moves upward, the spot position makes a profit, while the related futures position makes an offsetting loss.

Besides hedging strategies, arbitrage strategies and speculative strategies are also possible. Speculation means that uncovered futures positions (i.e. futures positions that are not covered by a corresponding position in the underlying asset) are deliberately entered into on the basis of subjective expectations and assessments of market or price trends for the underlying asset.

Interest-rate futures are mainly used to hedge against changes in the market levels of interest rates. The following two examples further illustrate the interrelationship between future and spot positions.

• The owner of a bond portfolio is worried about a rise in interest rates, which would lead to a fall in bond prices. In order to protect himself against rising interest rates, he can sell futures contracts.
• An investor who would like to purchase a bond in the future fears a fall in interest rates, and thus a rise in bond prices. In order to protect himself against falling interest rates, he can buy futures contracts.

Equity index futures allow one to lock in the current price level of a stock market. An existing portfolio of shares (i.e. a spot position) can be protected against the risk of falling prices by entering into an offsetting future short position. Likewise, the purchase price of a planned portfolio of shares which will not actually be constructed until a later date can, to a large extent, be locked in.

Equity index futures also allow participation in overall stock market trends. With just a single transaction, a very broadly diversified portfolio of shares may essentially be “purchased” (long position) in anticipation of rising stock prices, or “sold” (short postion) in anticipation of falling stock prices.