Profit on currency futures

The total volumes in exchange-traded foreign currency derivatives rose by over 57% from 55 million (2004) to 165 million (2005) contracts as per Futures Industry Association.

DGCX (Dubai Gold & Commodity Exchange) listed gold and silver futures before, but since Monday 12th June it's possible to trade currency futures as well. How are you supposed to do that? For whom is this interesting and why? What do you need to take into consideration?

As a private investor you can not directly participate in the market. Therefore you need to use a broker (usually a bank or another financial institute). Future contracts are available for Euro, Yen and Sterling against the US Dollar. DGCX brokers will be able to trade Euro/US Dollar, Yen/US Dollar and Sterling/US Dollar contracts, with other contracts coming on line over time.

Each of these currencies will have forward month contracts maturing in March, June, September and December. The contract size for Euro/Dollar and Sterling/US Dollar will be 50,000 while the contract size for Yen/US Dollar will be 5,000,000.

Margin trading

But if you just want to profit from movements in the Euro/Dollar exchange rate you don't need to pay 50,000 but fortunately much less. You only need to pay a margin, but remember, all of these contracts are physically deliverable. So if you don't want the currencies, make sure that you close down your position(s) before maturity.

I always compare currencies with stocks, and analogues, currency rates with stock prices. When a company performs well over time, its stock price will rise. The currency rate of a certain country will go up when the economy of this country is flourishing.

In that respect many analysts refer to the rate of the US Dollar. It should be about to be depreciated because the US economy is extremely dependent and financed by foreign money (supplied by other countries). However, remember that it is not that simple. The complexity of all relevant variables is enormous.

Currency futures are interesting to trade for private investors as speculators. But for companies future trading can be a significant part of their risk management. With these currency futures they can easily respond to events in global markets.

Derivatives

Derivatives (like options and futures) don't really create value but are used to transfer risk. In fact, it is called a zero-sum game; the buyer of a contract gains (or looses) as much money as the counterparty (seller) of the same contract looses (or gains). But, in order to manage (hedge) (currency) risk, companies may want to transfer some risk to others.

Professional and inter-bank proprietary traders will be using these instruments. But also corporate treasuries, importers and exporters can use these futures to offset currency risk, without the traditional need to be confined to banks or other large financial institutions for their foreign exchange (FOREX) market requirements.

Corporates having trans-national operations use currency derivatives to hedge against adverse movements in exchange rates. If a factory is based in Japan and buys commodities in US Dollars to manufacture goods and sells these products in Euros it is exposed to currency risk. The companies figures are denominated in Yen and companies always try to make their results (in their own currency) as stable as possible.

Dollar hedging

To offset this risk it is necessary to buy US Dollars beforehand (or buy doing a trade in a Yen/Dollar future). When (after a while) the Dollar loses value against the Yen, the company will be able to buy the commodities for a lower price in Yen than they had foreseen.

In the opposite situation, when the US Dollar rises, the company has to buy commodities that have become more expensive (in Yen). Now, when they set up a position in currency futures this loss may be offset by the profit on the currency futures.

Depending on how many futures where traded this compensation can be partial or the coverage will be complete. Either way, the results of the company become more dependent on their core business (manufacturing), and less on currency rate developments.

And it is possible to do a trade in Euro/Yen futures as well, to offset the risk involved with the front end of the company (the selling of the goods). Once the rate of the Euro declines versus the Yen, the company gets less Yen for the goods they sold. So, it might be wise to cover also this risk with futures.

What ever kind of participant you are, I wish you luck and prosperity in the currency markets!