FX futures contracts

[wrongsaidfred]

Hi David,

I may be over thinking this, but I am really confused as to what it means to be long or short an FX futures contract. For purely speculative purposes, let's say you expect the Euro to strengthen against the Swiss Franc.

I think the main idea is that you want to get long the Euro, which is the same as getting short the Franc. You think that Euros are going to be worth more Francs than they are today, so you would buy a contract that allows you to purchase Euros for Francs at a set rate. As the Euro gains strength over the franc, you would be making money on the contract. Does this sound about right?

On the other hand, you could say that you want to sell Francs for a certain amount in the future so you short a contract that will hopefully decrease in value. If the Franc devalues vs the Euro, the short position in the contract will make money.

My question is: would you get long a futures contract or get short a contract? The contract could be written in a number of different ways and I am at a complete loss as to how to think about it. It seems like it would be easy enough it it were spelled out in plain English, but this might not be the case.

Any advice you could provide would be geatly appreciated.

Thanks,
Mike

 

[David Harper CFA FRM]

Hi Mike,
I also need to think it through, not instantly obvious.

Take the current spot price of EUR/USD $1.3327; i.e., $1.3327 per 1 EUR
See http://www.cmegroup.com/trading/fx/g10/euro-fx.html

For me, the key is to liken currencies to other commodities, so here my focus is on:
Contract Size = 125,000 euro; i.e., the underlying commodity is Euros

(see specifications @ http://www.cmegroup.com/trading/fx/g10/euro-fx_contract_specifications.html)

it looks like the forward curve is pretty flat. March 2013 EUR/USD = $1.3352 (near to the current spot)

So, if we go long, as usual, we are promising to purchase the commodity in the future, in this case,
long 1 contract = a promise to pay $1.3352/ in return for delivery of 120,000 Euros
short 1 contract = a promise to delivery 125,000 Euros in exchange for payment (receiving) of $1.3352 per Euro delivered

Say we think the Euro will strengthen, or equivalently the dollar will depreciate versus the Euro.
Then, as usual, we take a long forward position @ $1.3352.
Say we are correct: EUR/USD increased from $1.33 to $1.40: we pay $1.33*125K and get 125K Euros (the forward), which are immediately worth $1.40*125K Euros. Our profit is ($1.40 - 1.33)*125K Euros.

If we think dollar we strength, we short the forward.
Say we are correct: EUR/USD weakens from $1.33 to $1.20; we purchase 125K Euros @ $1.20 but get to deliver (sell) them for the agreed-upon $1.33. Our profit is ($1.33 - 1.20)*125K Euros.

So, in summary, i just mentally liken the Euros (as the underling commodity) to ounces of gold or bushels of corn. To go long, in this particular currency pair, is to promise in the future to pay dollars in exchange for the underlying Euros.

(more realistically, we close out the forward at a profit rather than holding the contract to maturity. This is the among the most liquid markets in the world)

I hope that helps, David