Several organizations deal using foreign currencies which poses a danger to the firm due to fluctuating currency rates. A negative shift in the currency rate can result in significant losses. Therefore, these organizations use different trading tactics to avoid losses.
One such strategy is currency futures. Currency futures are standardized contracts between two parties made specifically for exchanging currencies.
Read this article until the end to better understand what currency future is.
Understanding Currency Futures
Currency futures, often called FX futures, are contracts or agreements to exchange one currency with another at a predetermined rate at a future date. In layman’s terms, one organization will pledge to buy a specific amount of another currency at an agreed-upon rate at a specified date.
Working of Currency Futures
Currency futures follow certain conditions such as currency pair, contract size, expiration date, and settlement mechanism. Typically, two parties are involved: hedgers (who protect their income from swings) and speculators (who want to profit).
Traders can take on long positions, where they purchase or bet that a currency will rise, or short positions, where they sell or forecast a decrease. Financial accountability is ensured by making an initial margin deposit with the broker.
Additionally, contracts are marked to market daily to account for profits or losses. Before expiry, traders have two options for contract termination resolution: physical delivery (exchange actual currencies) or cash settlement (receiving or paying the contract’s profit or loss in cash).
Popular Currency futures
Some actively traded and widely recognized currency futures are:
Euro Currency Futures (EUR/USD)
Euro currency futures include the exchange rate between the euro (EUR) and the U.S. It is one the most widely traded currency future.
Australian Dollar Futures (AUD/USD)
These involve the exchange rate between the Australian dollar (AUD) and the U.S. dollar (USD).
Canadian Dollar Futures (CAD/USD)
These are based on the exchange rate between the Canadian dollar (CAD) and the U.S. dollar (USD).
Use cases of Currency Futures
Currency futures can be used for several purposes. Some of them are listed below.
Hedging
Several investors, multinational companies and firms use currency futures contracts to hedge against the currency rate variation, minimize financial losses, and protect their revenues from adverse financial fluctuation.
Speculation
Trading and investing in currency futures provides a means for speculating on changes in exchange rates. Trading positions include long positions, where a trader purchases a futures contract and sells the contract at a profit later, and short positions, where a trader sells a futures contract repurchase at a lower price, making a profit.
Diversifying Portfolio
Using currency future, one gets exposure to the foreign market. Adding a currency future in the portfolio can spread risk and helps diversify the portfolio.
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