Carley Garner PortraitFutures For You

with Carley Garner

Inside The Futures World
Want to find out how the futures markets really work? Carley Garner is the senior strategist for DeCarley Trading, a division of Zaner Group, where she also works as a broker. She authors widely distributed e-newsletters; for your free subscription, visit www.DeCarleyTrading.com. Her books, Currency Trading in the Forex and Futures Markets, A Trader’s First Book on Commodities, and Commodity Options, were published by FT Press. To submit a question, post your question at http://Message-Boards.Traders.com. Answers will be posted there, and selected questions will appear in a future issue of S&C.

I’m interested in trading foreign futures in an account held at a US brokerage firm; what should I be aware of?

Most US brokerage firms offer their clients access to foreign futures and options. If your broker doesn’t, you should reconsider where you house your commodity trading account. Even if you don’t intend to trade foreign markets, that they are offering you limited product access is a telltale sign of a brokerage that simply isn’t equipped to specialize in commodity trading. Perhaps their focus is in stocks or FX, but it isn’t futures.

Some of the most popular foreign futures contracts are the German DAX (a stock index futures contract), the German bunds (sovereign debt futures), and canola oil (a.k.a. rape seed traded on the ICE Canada exchange).

Trading in foreign products can complicate the accounting on your brokerage statements because such products are not traded in US dollars, as contracts on domestic exchanges are. Instead, they are valued and traded in the designated currency in which the exchange is located. For instance, those buying or selling the DAX futures are not making or losing US dollars on each trade; instead, they are accumulating profits and losses in euros. Similarly, if you buy and sell a canola futures contract, your profit & loss will be calculated in Canadian dollars. In other words, upon exit of the position, your account will either be credited or debited in “loonies.”

Brokerage firms will typically give you the green light to trade foreign products in your account even though you are holding US dollars on deposit for margin. Once you do, your account will no longer be valued in a single currency. Your brokerage statement will display the current US dollar balance along with the balance of any other currency resulting from trades executed in foreign markets.

For instance, if a trader started with $10,000 and netted a profit of 200 euro on a DAX trade, his statement would display $10,000 and a separate account balance of 200 euro. The net is then figured by considering the current exchange rate (typically the 5 pm reading of the spot FX price on the statement date) and displayed on a third line of the brokerage statement. Assuming a value of $1.35 for the euro, the client account statement would read a “combined currency balance” of $10,270 ($10,000 + (200 euro 1.35)). For simplicity, this example ignores transaction costs associated with the trade.

A mistake that many traders make is to assume that their foreign currency balance is riskless cash holding. Nothing could be further from the truth. If your domestic currency is the dollar, and you are holding a positive euro balance in your trading account, you will eventually need to convert the euro holdings into dollars. The conversion is done at the current exchange rate, which might or might not be the same market rate that existed at the time the foreign currency was amassed through futures trades. Accordingly, your foreign currency balance is subject to currency risk!

Using the example above: There is little harm in holding a positive balance of 200 euro because fluctuations in currency values will have little impact on the bottom line. However, should your euro profits accumulate to a substantial amount, the risk can be real. Imagine holding 5,000 euro while the exchange rate moves from $1.35 to $1.20. In such a scenario, your “combined currency balance” would fall by $750. This is because 5,000 euro at $1.35 is worth $6,750, but if the euro is valued at $1.20, it’s only worth $6,000. This trader would have suffered a $750 loss without ever placing a trade in the futures market.

In other words, holding a positive euro balance in a trading account is equivalent to an unleveraged speculation on the long side of the euro. Keep in mind as well that if your ventures into the foreign futures markets yields a loss, you will be holding a negative currency balance, which carries risk equivalent to being short the currency.

As the value of the euro fluctuates, so will your account balance. I’ve seen traders unknowingly bring an account into negative status (where losses exceed their account balance) by holding euros during a volatile currency environment. This can happen if a trader takes a break from the market with a small “combined currency balance” but large balances in individual currencies. Specifically, a trader with a positive USD balance of $20,000 and a negative euro balance of 15,000 will have a combined currency balance of about $250 if the euro is valued at $1.35, but the $250 positive balance can easily disappear if the price of the euro goes up.

Speculating in the futures markets is a difficult game; don’t make it even more difficult by being ignorant of the impact of trading foreign futures and the resulting currency balances. Be educated, be aware, and proceed accordingly.

Originally published in the December 2013 issue of Technical Analysis of Stocks & Commodities magazine. All rights reserved. © Copyright 2013, Technical Analysis, Inc.

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