Q&A
Futures For You
Inside The Futures World
Want to find out how the futures markets really work?
DeCarley Trading senior analyst and broker Carley Garner responds to your questions
about today’s futures markets. To submit a question, post your question
at https://Message-Boards.Traders.com. Answers will be posted there, and selected questions will appear in a future issue of S&C. Visit Garner at www.DeCarleyTrading.com. Her books, Commodity Options and A Trader’s First Book On Commodities, are available from FT Press.
DISTINCTIVELY DIFFERENT DELIVERY
Why are there dramatic differences in the way the yen is quoted in the futures market relative to the foreign exchange market?
There are distinct differences between the futures and the forex markets that create dramatically different pricing for the yen, yet in both markets the currency’s inherent value will always be similar. For starters, yen futures and the dollar/yen currency pair in forex are each quoted in different terms; second, forex contracts represent immediate delivery and futures represent “future” delivery, which causes some variation in pricing.
Although speculators are essentially betting on the same underlying assets when trading currencies in either the forex or futures market, very different standards are set in each trading arena. For instance (ignoring the relatively new currency pair futures introduced by the Cme Group and Ice), the traditional Cme Group currency futures are all paired against the US dollar. Specifically, all are quoted and traded in terms in which the dollar is the quote currency. The price you are buying or selling a currency futures contract at is quoted in terms of the US dollar. For instance, if the euro is trading at 1.3345, it takes exactly $1.3345 to purchase a single euro.
The value of a single yen is nearly worthless and can be thought of as similar to a penny in US currency.The yen is an exception in the currency world. The value of a single yen is nearly worthless and can be thought of as being similar to a penny in US currency. That is, if the US dollar didn’t exist and all of our transactions took place in pennies, the US currency would trade like the yen. You might see the yen futures contract quoted at a rate of 1.22400. Unlike the euro, this does not mean it would cost $1.224 to buy a single yen. Instead, it can be looked at in two ways; the price of a yen is 1.224 cents, or the cost of 100 yen is $1.224.
However, currencies in forex aren’t always traded in the same manner. In forex, traders are executing buys and sells on a pair, rather than a single currency that is automatically paired against the dollar. Yen speculators have the freedom to place wagers on the value of the yen relative to the euro, the Canadian dollar, and many others. In pairs trading, buying one currency means selling the currency it is paired with. To illustrate, if you are buying the Eur/Usd it is the equivalent of simultaneously purchasing the euro and selling the US dollar. It isn’t any different from buying the euro against the dollar in the futures markets, but the reality isn’t displayed in nearly as obvious of terms.
Forex pairs are standard regardless of the brokerage firm you choose. In essence, you can trade the Eur/Usd pair, but you couldn’t trade the Usd/Eur pair. If you wanted to be long the US dollar, you would simply sell the pair (that is, sell the euro and buy the dollar).
In the case of the yen, it is traded against the greenback in the standard Usd/Jpy pair, which is the opposite of the yen futures contract traded on the Cme Group. Therefore, the price quoted for the yen futures and the Usd/Jpy are the inverse of each other. Accordingly, the Usd/Jpy in the forex market will be trading in the 80s while the yen futures contract (essentially the Jpy/Usd, if there were such a thing) will be trading in the 1.20s.
For instance, assume a yen futures value of 1.22400 is the equivalent to one yen/1.22400 (Jpy/Usd) or one yen is equal to 1.22400 cents. The inverse of this can be found by dividing one by 1.22400 (1/1.2240), or 0.8169. In forex, however, you will see the yen quoted with two digits on the right of the decimal such as 81.96. By moving the decimal, the price is now quoted in the cost per one US dollar. In other words, 81.96 yen are required to purchase one US dollar.
Adding to the complexity, unlike the Usd/Jpy currency pair in forex, yen futures are priced for future delivery (as the title of the contract implies). The forex market is known as the spot market because delivery of the underlying asset is set to occur immediately should a trader fail to “roll” their contracts to a distant delivery date (usually the next day). Currency futures, on the other hand, represent quarterly delivery of the underlying. There are four delivery months: March, June, September, and December. Futures speculators not interested in taking delivery of a currency will only need to roll their positions four times per year, as opposed to daily.
Because delivery takes place at a specific date in the future, the market tends to have expectations as to what the value of any particular currency will be at that date. Just because the Usd/Jpy is trading near 81.69 today doesn’t mean the futures contract set for delivery three months (or more) from now will be trading at or near 1.2240. Variations in the value might stem from expectations of interest rates, or other fundamental factors.