Currency Futures Price Sensitivity

Currency futures prices are sensitive to changes in each of the components in the pricing model. In other words, currency future prices are sensitive to changes in the underlying exchange rate and the interest rate differential between the two countries in question.

The Basis

The difference in price between the currency futures and the underlying exchange rate is called the ‘Basis’. The Basis reflects a number of factors, collectively called ‘Carrying Costs’ (e.g. interest differential). The Basis difference narrows as the currency future contract nears expiry this is known as basis convergence.

Minimum Contract Size

Currency futures have a minimum contract size of 1000 foreign underlying currency (e.g. $ 1000).

Expiry Months and Date

The expiry months specified for foreign currency futures contracts are March, June, September and December. All currency futures contracts expire two business days prior to the third Wednesday of the expiry month or, if that day is not a business day, then the previous business day.

Expiry Prices

The price at which the foreign currency futures contracts expire is calculated from an arithmetic average of the underlying spot taken every 60 seconds for 100 iterations between 12h01 and 13h40. If less than one hundred iterations have been accumulated by the expiry time for the computation of the expiry price, then the computation and publication of the expiry price shall be postponed until one hundred iterations have been accumulated.

Settlement

The foreign currency futures contracts are cash settled in Rand. In other words, no physical delivery of the underlying currency will ever take place.

Margining

Each trade is matched daily by Yield-X, i.e. the exchange ensures that there is a buyer and a seller to each contract traded. The JSE’s clearinghouse Safcom becomes the counterparty to each trade once each transaction has been matched and confirmed. The clearinghouse therefore ensures settlement takes place on each trade. To protect itself from non-performance, Safcom employs a process known as margining. This mechanism is two-fold.

Initial Margin

Firstly, when a position is opened (either long or short), the investor is required to pay an initial margin in cash with the broker who subsequently deposits it with the clearinghouse. This amount remains on deposit as long as the investor has an open position. The initial margin attracts a market related interest rate which is refunded to the investor once the position is closed out, or if the contract expires. The initial margin requirement varies between the different currency futures offered.

The Bid/Ask Price

Like equities, foreign exchange has a Bid price and an Ask price. The bid is where the market maker will buy. The ask is where the market maker will sell. For investors, the reverse is true.

The bid price is where an investor can sell, while the ask is where an investor can buy.
The bid price is always less than the ask price. This makes logical sense as a market maker, like any investor, wants to buy low and sell high.

The spread between the bid and the ask is called the Bid/Ask Spread or Dealing Spread. The bid/ask spread is the premium that market makers charge to provide constant liquidity to a retail client base.

For example, the bid and ask might be 1.2050/1.2055. The spread is 5 pips.
Paralleling foreign exchange trading to equities, a market maker, like FXDD, is the equivalent of a specialist on the floor of the exchange.

A specialist is always willing and able to make a market (i.e. provide liquidity) to the market/investor. For this service, he will have a bid where he buys the stock and an offer or ask, where he will sell the stock.

The bid/ask spread the specialist charges will fluctuate with the general liquidity of the underlying stock.

That same principle applies to FXDD's Bid/Ask Spreads.

Dealing Spreads for the major currencies pairs on FXDD are 2-3 pips wide. Some less liquid currencies will be a bit wider.

This reflects the relative liquidity/risk in the professional market for that particular currency pair.

The dealing spreads that we quote reflect a normal market making spread given the risks we take and the costs we incur for servicing our clients' business.

Obviously, if the volatility and risk of making a market increase because the markets become less liquid, it stands to reason that our spreads will increase as well.

These are universal realities of market makers and should not come as a surprise to knowing investors/traders.

Buying and Selling Foreign Exchange

What exactly do you buy or sell when you make a foreign currency transaction?

In reality, you are doing both actions - buying and selling. A transaction of Buying the EUR/USD at 1.2000 is actually buying the Euro and selling the Dollars at 1.2000 cents. If the Euro increases in value in relation to the dollar, the price would increase and the investor will make money.

If for whatever reason, a trader could not execute an order using FXDD, a verbal order to a broker could be the following:

"I buy 100,000 Euros and sell the dollar at the Market"

or

"I buy 500,000 EUR/USD on a 1.2100 stop"

or

"I buy 100,000 Euros vs. the Dollar at the market"

What is required on all verbal orders is the amount, the Currency Pair, the rate and/or the type of order. Simply saying "I buy the Dollar at the Market" is not good enough as it does not say what currency the trader wants to sell.