I understand why futures markets exist for e.g. oranges (seasonal production cycles) and jet fuel (to avoid storing a years' worth yourself). But currencies are available 24/7/365 and have zero storage cost.
2) Currency futures markets exist to allow you to bet that the value of the currency will decrease, by offering to sell you the currency at price below the current market rate in the future.
In markets where there's no easy/legal way to bet that prices will decrease, asset bubbles are common, as "bulls" bid up the price, and "bears" just sit on the outside waiting for the bubble to pop.
If bears could bet that the value would decrease, this would lower the price of the asset today. In this way, price signaling can allow the market to reach an optimal shared opinion about the "true value" of an asset.
There are a lot of cryptocurrency bears who think that the long-term value of Bitcoin and Ether are approximately zero, that cryptocurrencies are in an asset bubble, and that this is wasting valuable time and money that the economy should spend on other things. By betting against cryptocurrency, bears could help to end the bubble in a safer and slower way.
(Or so they say. Sometimes future markets can exacerbate price instability when the whole market behaves irrationally.)
(The other reason futures markets exist is to allow people holding the currency to reduce ("hedge") the risk that the value of the currency will decrease. Thus they can make small bets against the currency, and if it rises, they'll still make money, and if the value falls, well, at least they'll win their bet.)
Instead, I could have just bought the 0.79 GBP immediately and then waited 3 months, and then I would have profited even more: 0.79 - 0.7 = 0.09 GBP.
What does the existence of the futures market allow me to do that I can't already do in this scenario?
My point was that in cases where production is cyclical or storage fees are nonzero, it might be difficult/impossible to trade on the spot market, or it might be prohibitively expensive to hold the item yourself. But currencies don't have either of these problems.
Additionally futures aren't just for "betting" they are also for offloading risk. For example a company might expect an sale in another currency and might want to "convert" that earlier to offload the risk of making another purchase in a different currency.
2. Holding spot currency position is not "zero storage cost", you need to pay daily interest - futures has this built-in in their price.
3. Futures are leveraged
4. Futures contracts are standardized - which makes finding counterparty much easier and allow market makers.
5. Futures traded on regulated exchanges (CFTC in US), unlike spot FX - which is more similar to how crypto exchanges operate.
What's the point in splitting hairs. A future is a standardised form of a forward contract, generally so they can be traded more easily. It doesn't affect the underlying financial concepts.
Do the calendar spreads, implieds, volatility, high performance matching engine, and market makers.
Existing exchanges have been amazed to find out that these 'hacks' aren't even the end of the money train, you can create derivates of the hacked money to let customers re-deposit and trade even further! It is an amazing new world of finance!
Leverage.
So I had a look at live data for an example. As of writing, 1GBP = 1.28 USD. Let's look at some example scenarios, assuming I believe 1 GBP will be worth 1.41 USD (+10%) in 3 months and want to make as much money as I can with a $100k investment.
- I buy USD from a regular bank or currency exchanger and wait 3 months. If the price goes up 10%, I make $10k. If the price goes down 10%, I lose $10k. If nothing happens, I lose nothing.
- I buy GBPUSD futures contracts. I need $7346.25 margin to open the contracts and $5877 to maintain them (per https://www.interactivebrokers.com/en/index.php?f=marginnew&...) and I control 62500GBP ($80k) per contract. With $100k, I can buy 13 contracts and control $1.04M. If the price goes up 10%, I make $100k. If it goes down 10%, I lose $100k.
And then, for fun:
- I buy 86 options for a GBPUSD futures contract at a strike of $1.28 for $99k. If the price goes up 10%, I make $593k. If the price is at ~$1.30, I lose nothing. If the price is below $1.28, I lose $99k.
I'm no expert on futures however so there might be something wrong here, though the answer is definitely leverage.
We can trade GBP/USD between each other with as much leverage as we like without any future time conditions. All we need do is agree to pay each other the difference in value as the price changes, multiplied by our agreed leverage.
At some point, one or other of us can close the deal and settle the outstanding amount.
If you can't strike a deal directly, you go to an exchange or clearinghouse of some kind that will introduce buyers and sellers. Once again, leverage can be created without any forward or future.
Forwards came first. You would go to an investment bank tell them you wanted to hedge whatever you had and they would write up the contract between you and them. Obviously there is no secondary market for these things and two contracts could have different terms in them.
So futures were invented. They standardized the underlying product (e.g. a type of wheat, a particular duration on bonds, a fineness of metal, etc), the expiration date, the delivery location (or financially settled), and the size. Now since all these contracts are fungible a market can be formed to trade them back and forth.
Those are basically the only differences.
I see how the second case (waiting six months to convert USD to CAD) involves currency risk. But I don't understand how the first case involves currency risk. If I converted some USD into 1.3MM CAD today, and then held it for six months before paying my vendor, what currency risk did I incur that is eliminated by the futures contract?
An FX future has the same currency risk profile as exchanging now. What is different is you trade on margin, and you have interest rate risk in a different currency.
People who actually want to fix an FX rate in the future would use a 'forward', simply a contract to exchange at a later date. Again no change in FX risk.
The true hedge is an FX option, where you can lock in a price (for a fee) yet still back out if you want to.
You know what the cost of carry is up to the futures expiry date, so you use that (non arbitrage) to set the adjustment for the futures price.
So then when you trade the future, you're not in need of settling some item (currency, bonds, cows) against some payment each day.
Currencies are indeed available each day, and are easily settled each day, but there's a number of reasons why you might want the future:
- If you settle each day, your account PnL depends on interest payments. With futures, it's just the difference between the prices traded. So easier to account for.
- Futures tend to be cheap to trade. Depends on your agreements. You have to pay interest on one side and receive it on the other side if you settle currency. And guess what, your prime broker gives you a crap rate on both!