CURRENCY TRADER. Currency Trading. Introduction to currency futures. What are currency futures?

Transcription

1 Introduction to currency futures The South African Rand is one of the most volatile currencies in the world; it can exhibit moves of greater than 0.20c in a single day of trading versus the US dollar. This volatility allows investors to speculate by being in the market for a relatively short period of time and offers excellent liquidity supported by market makers. The EURO/ZAR, GBP/ZAR, EURO/USD, GBP/USD also offer excellent liquidity but they are slightly less volatile when compared to the USDZAR offering moves ranging between 0.01c-0.10c in a single trading day. The Rand is a floating exchange rate which simply means a currency is free to float to the relative levels against other currencies as is determined by market forces of supply and demand with limited intervention by monetary authorities. There are a number of reasons for South African Rand volatility. The Rand s traded value is closely linked to changing market sentiment. The Rand is often described as a proxy for emerging markets and frequently takes the brunt of economic developments in the United States and Europe. Secondly, South Africa s economy is commodity based. The South African Rand therefore shares behavioural characteristics with other commodity based currencies such as the Canadian Dollar and the Australian Dollar. Commodity prices of oil and copper and especially those of precious metals such gold and palladium are priced in US Dollars, impact commodity currencies and subsequently the Rand. As an emerging market currency the ZAR is also influenced by market events that affect the emerging markets and their currencies such as the Polish Zloty, Brazilian Peso, Russian Ruble, Turkish Lira and Hungarian Forint. In addition, the traded value of the Rand is a gauge of market sentiment with respect to South African domestic political and economic fundamentals. An additional factor is that South Africa is geographically situated half way between Asia and the US markets, an important factor considering that currency markets operate globally 24 hours a day. South Africa currency traders therefore have access to 3 trading days/times zones (Asia/Europe/US) in a single South African trading day between 09:00 and 17:00 What are currency futures? The Johannesburg Stock Exchange (JSE) introduced currency future contracts during 2007 to allow local traders the ability to gain exposure to foreign currency movements relative to the Rand without affecting their offshore allowance. Essentially, currency future contracts allow traders to benefit from the movement in the currency futures rate between the Rand and several major international currencies. Currency traders can also buy and sell currency pairs in order to obtain "long" or "short" exposure - in other words make money while the currency exchange rates move up or down. This happens automatically when the investor decides to either buy Dollar and sell Rand - or buy Rand and sell Dollar. Currency traders do not have to deposit cash to match the whole value of the futures position as currency future contracts are geared. Currency traders need only deposit enough cash to cover the initial margin, which is a fixed rand amount per contract equal to between 10% and 20% per contract. (See below) As one of the few full time dedicated currency futures brokers PSG Online possesses the expertise and skills to allow clients to trade currencies with confidence. We offer world class risk systems and an expert team of professional currency traders who will provide you with regular currency trading ideas to decipher market movements.

2 What is the difference between currency futures and forex trading? Those looking to profit from fluctuations in currency valuations have two currency trading forums, spot forex trading and currency futures. In general, spot forex traders physically exchange the underlying currencies on the settlement date, there is an actual exchange of the underlying assets. For example, when a person goes to a bank to do a currency exchange, that person is participating in the forex trading. The main difference between spot forex trading and currency futures is when the currency trading price is determined and when the currency pair exchange takes place. The price of currency futures is determined when the currency futures contract is signed and the currency pair is exchanged on the future delivery date. The price of spot forex trading is also determined at the point of trade, but the currency pair exchange takes place immediately or shortly thereafter. It is important to note that currency traders in the futures currency futures markets are speculators who usually close out their positions before the date of settlement, so most currency futures contracts do not last until the delivery date. Currency futures are often used as hedging instruments by forex trader. Currency futures have opened up the market to smaller currency futures traders to trade currencies effectively through gearing. Reasons for trading currency futures Currency futures are standardised currency exchange contracts that are traded on the JSE's currency exchange, YieldX, an exchange with a centralised order book. This means that buy and sell prices are posted in real-time onto the central market by the relevant market makers. This allows for transparent pricing of the currency exchange. Being a listed product has numerous benefits: 1. Futures are geared products, which mean currency traders do not have to deposit cash to cover the full value of the position. 2. Futures allow individual investors to take a view on the movement of the currency futures rate and provide them with access to favourable rates usually reserved for larger corporate clients. 3. Tight spreads and low currency trading costs allow clients currency futures traders to enter and exit positions in the knowledge that profits are not being paid away each time there is a trade on the account. 4. Importers and exporters can dynamically hedge their currency risk far more efficiently using futures due to the ease of entering and exiting futures positions and the low cost per trade. 5. The presence of dedicated market makers ensures market liquidity and ensures that currency traders can open and close currency exchange contracts with multiple counterparties. 6. The daily mark-to-market process allows clients the ability to track their profit or loss situation and to adjust their portfolio accordingly. 7. Once the position has been closed out all settlement occurs in Rand. What currency futures contracts are available? Futures offer traders looking for a hedge a variety of advantages as a means to manage their currency risk and speculators a low cost option to express their currency view. The currency pairs currently available to trade against the Rand on the JSE's YIELDX exchange are. 1. US Dollar 2. Euro 3. British Pound 4. Aussie Dollar 5. Japanese Yen 6. Canadian Dollar 7. Swiss Franc One can also trade synthetic crosses for example, EUR/USD, GBP/USD and GBP/EUR. Synthetic trades are becoming increasingly popular amongst investors as the margin requirements are considerably less than Rand bases crosses.

3 How does a currency future work? Futures trade in standard contracts, with quarterly expiry dates of (19 March/19June/19Sep/19Dec). Most speculators will trade the near dated contract as this is the most liquid contract or most tradable contract. One contract exposes the investor to of the underlying foreign currency. (i.e. USD 1,000.00). This gives investors a gearing ratio of 1:11. In order to open the futures position; the investor must deposit the necessary cash equal to the margin with the JSE. This amount is calculated by multiplying the number of contracts by the margin per contract. Margin is a good faith deposit and is returned at the end of the trade, less losses or plus profits. Margin is calculated as follows [number of contracts x (margin amount x 2)]. Margin amount for example on March 12 USDZAR contract is R per contract; however investors must deposit double margin per contract. For example if you bought 5 USD/ZAR March 12 contracts, the margin required would be 5 x (R360.00x2) = R Remember margin/collateral is a deposit and not a fee. Brokerage is R18.00 per contract. For example if you bought 5 contracts, brokerage requires would be 5 x R18.00 = R90.00 (Brokerage is paid to open and close the position). The future is cash settled, there is no physical delivery of foreign currency. Risks of trading currency futures Trading carries risks and derivative trading is no exception. Currency futures are geared instruments. One contract exposes you to in the foreign underlying currency. One contract requires R in margin. With this leverage/gearing you are able to make large profits from small initial layouts of capital. However the opposite is also true. Should the trade move against you, you could incur large losses as a result of the leverage/gearing. There is a risk that you may lose more money than you initially invested. The most important thing to remember is that not every trade will be a successful trade resulting in profits. The secret to trading currencies is to input tight stop losses and not to allow losses to run away. This way you limit losses and manage your risk. With every trade you should also have a target in price in mind. Be strict and diligent. Don t trade on emotion; trade on fundamentals, a strategy, logic with some common sense. Once your target price is reached, execute and get out of the trade. Re enter the market with a new trade and trading strategy. It is very tempting to ride a trade into profit and stay in the trade looking for larger gains. This can go wrong and you may well ride the trade all the way back into losses before closing your position. Some of the advantages of trading currency futures include. 1. A known currency rate can be traded and locked in. 2. The spot market price and currency future price move in union with each other. The future price trades at a premium to the spot as has incorporated the interest rate differential between the two chosen currencies from present to the contract expiry date. 3. There is no need to hold the futures contract till expiry, the contract can be closed or traded out at anytime. 4. Due to the fact that the contracts trade on the South African Futures Exchange (SAFEX), investors enjoy a liquid market with dedicated market makers making competitive prices with tight spreads. 5. The currency contracts can be rolled every three months.

4 Why trade with PSG when there are other brokers? PSG is a well known and respected financial services provider in South Africa. PSG is regulated by the financial services board of South Africa as well as a member of the Johannesburg Stock Exchange. PSG traders are competent traders who are approved by the JSE and authorised to trade on the JSE.PSG is able offer a competitive trading brokerage of R18.00 per contract, this includes the JSE clearing and settle fee. The spreads/prices that you receive are the same spreads/prices that are trading on the JSE; PSG does not add to or adjust the spreads/prices. There is no monthly account fee. You only pay when you trade and payment is per contract. As a PSG client, you are giving free access to our PSG online trading platform which will allow you to trade in your own time and in the comfort of your home or office. In addition you may also or phone an order through to the trade desk at no extra charge. You will receive daily market research, market commentary, trader s views, trading ranges and trade ideas to help you make informed and educated investment decisions. You are welcome to call the trade floor and talk directly to the trader and ask any questions or advise with regards to trading of currencies How can you start trading currencies futures? You are welcome to contact our skilled currency futures team at or via info@psgonline.co.za. They will arrange the opening of the account and ensure that all your trades are executed at the best available price. You will also receive daily statements showing your margin and cash movement. The PSG Online trading platform is efficient and well-resourced; we have the systems and support to help you. If you wish to start trading using the PSG Online platform, you will have the use of a number of free services. You can register online to start trading currencies at the following address Who is the currency trader at PSG? Our PSG Online derivatives trader is Lynden Reabow. He is an experienced trader who has worked in the financial services sector for 10 years. He has a B Sc from Stellenbosch University and has been with PSG Online since August Before this he was London-based, and worked at the Royal Bank of Scotland and Citigroup. He is willing to guide investors through the process of trading currencies. You are welcome to call Lynden so that he can walk you through currency trading over the phone. Lynden will be able to offer experienced advice and guidance regarding the currency markets in addition to trade ideas and other trading related questions that you may have. He also produces a daily morning report that is sent to all clients in the morning that summaries global commentary, offers fundamental and technical analysis, economic data to watch, his view on the market and a technical trading range for the day. Lynden is contactable on or and his address is Lynden.Reabow@psgonline.co.za

5 Glossary American style option An option that can be exercised at any time between the purchase of the option and expiry. Arbitrage Taking advantage of price discrepancies in two related markets, to lock in a profit. Base currency The currency in an exchange rate quotation expressed in terms of the number of units of the other currency in the quotation (the variable currency). (Also home currency) Bearish Expecting a fall in financial instrument / market prices. In foreign exchange: a fall in the price of the base currency. Bid The price at which the dealer quoting a price or rate is prepared to buy. Bullish Expecting rising financial instrument / market prices. In foreign exchange: a rise in the price of the base currency. Call option An option, without the obligation, to buy an agreed amount of a particular financial instrument or commodity, at an agreed rate, on or before an agreed date. Cash Market (Also spot market) The market for trading a financial instrument, where settlement takes place on the normal delivery date. As opposed to futures, options or forwards (where delivery is for a later date than normal). Cross-rate An exchange rate between any two currencies, neither of which is the US dollar. Currency option An option which gives the owner the right to buy or sell the indicated amount of foreign currency at a specified price on or before a specific date. Currency risk The risk that a fluctuation in exchange rates may adversely impact on the value of an investment denominated in a foreign currency. Currency swap An exchange of a series of cash flows in one currency for a series of cash flows in another currency, at agreed intervals over an agreed period, used to change the currency exposure of the investment. Derivative Any financial instrument whose value is derived from another, such as a forward foreign exchange rate, a futures contract, an option, an interest rate swap etc. Double A quote of a buy and sell price for a currency. ECB European Central Bank. European style option An option that may be exercised only at expiry.

6 Glossary Exercise (an option) To require the seller of an option to fulfil his obligation in terms of the option. Expiry date The final date on which an option can be exercised. Fed Federal Reserve Bank of New York. Authorised financial services provider dealing in forex investments Forward (agreement) A deal for settlement later than the normal settlement date for that particular financial instrument. Forward foreign exchange All foreign exchange transactions to be settled more than two business days in the future. Forward outright (Outright forward) An outright currency in exchange for another currency for delivery on a fixed future date beyond the normal (spot) settlement date. Forward swap The purchase of one currency against another for settlement on one date, with a simultaneous sale to reverse the transaction on a subsequent settlement date. Futures contract A deal, traded on a recognised exchange, to buy or sell some financial instrument or commodity for settlement on a future date. Hedge Protect against the risks arising from potential movements in exchange rates, interest rates or other variables. Initial margin Collateral placed with a clearing house at the time of a deal, against the possibility that the market price will move against the trader, thereby leaving the counter party with a credit risk. Interest rate differential The differences in interest rates between two countries. Intervention (intervene) A government, or central bank taking action to influence the value of its currency. In-the-money An option whose strike price is more advantageous to the option holder than the current market rate. Leverage Means the usage of a relatively small foreign currency margin deposit to control a much larger foreign currency amount. Also known as gearing. The leverage employed is usually expressed as a ratio being the ratio of the margin deposit to the total value of levered foreign currency. LIBOR London Interbank offered rate, the rate at which banks are willing to lend to other banks. Liquid An investment easy to sell or a position easy to close out. Long Owning or buying a given currency or asset.

7 Glossary Margin A specified amount of money required by a dealer to insure against risk of lossesfrom outstanding positions. Mark to market Revalue a position at current market rates. Market maker A dealer in foreign exchange who will risk his own capital by offering both buy and sell quotes in a currency. Market makers add liquidity to the market. Offer The offer price of a foreign exchange quotation is the rate at which a dealer will sell the base currency and buy the terms currency. The offer price is therefore the price the client will buy Option The right, without any obligation, to undertake a particular deal. Out-of-the-money An option whose strike is less advantageous to the option holder than the current market rate. Over-the-counter (OTC) A transaction dealt privately between any two parties, rather than dealt on an exchange. Outright forward (Forward outright) An outright purchase or sale of one currency in exchange for another currency for delivery on a fixed date in the future other than the spot settlement date. Par In foreign exchange, when the forward outright and spot exchange rates are equal, the forward swap is zero or par. Pip The smallest incremental value by which an exchange rate move is measured in the foreign exchange market. Points The last two decimal places in an exchange rate. Premium The amount by which one currency is more expensive, in terms of another currency for forward delivery than for spot. Put option An option, without the obligation, to sell an agreed amount of a particular financial instrument or commodity, at an agreed rate, on or before an agreed date. Short Not owning or a selling of a given currency or asset. Speculation A deal undertaken because the dealer expects prices to move in his favour. Spot (spot rate; spot market) A deal to be settled on the customary settlement date for that particular market. In the foreign exchange market, this is for value in two working days time.

8 Glossary Spread The difference between the bid and offer prices in a quotation. Strike price/rate The price or rate at which a holder of an option can insist on the underlying transaction being fulfilled. Volatility A measure of how much the price of a financial instrument fluctuates within a specific time period. Writer The Seller of an option. Yield The interest rate that can be earned on an investment.