What it means
A currency future is essentially a forward contract that has been standardised and moved onto an exchange. Instead of negotiating an amount and date with a bank, the user buys a fixed-size contract that expires on a published date.
The main advantage over a bank forward is credit safety and transparency. The exchange clearing house stands between buyer and seller, prices are public, and a position can be closed by trading the opposite contract rather than by renegotiating with a counterparty.
The main disadvantage is fit. A business owing a specific amount on a specific day rarely matches the contract size or the quarterly expiry, so a futures hedge leaves a small residual exposure that a tailored bank forward would not.
Futures are margined daily, which is a real cash flow consideration. A position that moves against the holder generates a margin call the next morning, so a hedger needs spare liquidity even when the underlying commercial exposure is perfectly offset.
Contract specifications are worth learning once. The euro contract on a major exchange covers 125,000 euros, the pound contract 62,500 pounds and the yen contract 12,500,000 yen, and the minimum price move on each translates into a fixed dollar tick value.
In practice
Real-world examples.
Example
A Canadian aerospace supplier expecting a $6,000,000 US dollar payment in four months buys Canadian dollar futures to fix the conversion rate. When the Canadian dollar strengthens before payment day, the gain on the futures offsets the smaller Canadian dollar amount the payment converts into.
Example
A commodity fund with a bearish view on the Japanese yen sells 20 yen futures contracts of 12,500,000 yen each, a notional exposure of 20 x 12,500,000 = 250,000,000 yen. It posts far less cash than that notional because futures are margined, but it also faces daily margin calls whenever the yen rallies.
Example
A US importer compares a bank forward with an exchange-traded future for a 500,000 euro payment. The future needs 500,000 / 125,000 = 4 contracts and expires two weeks after the invoice falls due, so the treasurer accepts the small timing mismatch in exchange for tighter pricing and no bank credit line.
Formula
Calculation
Contract notional value = Contract size x Futures price
Profit or loss = (Exit price - Entry price) x Contract size x Number of contracts
A US company must pay a European supplier 1,000,000 euros in three months and wants to fix the cost. The euro futures contract covers 125,000 euros, so it needs 1,000,000 / 125,000 = 8 contracts.
It buys 8 contracts at 1.0850 dollars per euro. Notional per contract = 125,000 x 1.0850 = $135,625, so total notional = 8 x $135,625 = $1,085,000. Initial margin of $2,500 per contract means 8 x $2,500 = $20,000 of cash posted.
By expiry the euro has risen to 1.0975. Futures gain = (1.0975 - 1.0850) x 125,000 x 8 = 0.0125 x 125,000 x 8 = $12,500.
Buying the euros in the spot market now costs 1,000,000 x 1.0975 = $1,097,500, which is $1,097,500 - $1,085,000 = $12,500 more than budgeted. The futures gain offsets that extra cost exactly, so the effective rate stays at 1.0850.Case study
Seen in the real world.
Kestrel Instruments, an invented US maker of surveying equipment, is used here for illustrative purposes. It bought optics from a European supplier and had watched a 6% currency move turn a profitable quarter into a flat one, so its new treasurer proposed hedging with exchange-traded futures.
Forecast euro purchases were 3,000,000 euros over the next twelve months, so the company bought 3,000,000 / 125,000 = 24 contracts spread across four quarterly expiries. Initial margin at $2,500 per contract came to 24 x $2,500 = $60,000, and the treasurer negotiated a $150,000 committed facility purely to fund possible margin calls.
Over the year the euro fell, so the futures lost $46,000 while the cheaper euros saved almost the same amount on supplier invoices. The board's first reaction to the futures loss was alarm, and the treasurer's most useful work turned out to be explaining that a hedge is supposed to lose money exactly when the underlying exposure gains.
Watch out
Common mistakes.
- Judging a hedge by the profit or loss on the futures alone, rather than by the combined result of the hedge and the underlying commercial exposure.
- Forgetting that futures are settled daily, so a hedger without spare cash can be forced to close a sound position just to meet a margin call.
- Assuming the contract size and quarterly expiry will match the business exposure, leaving an unnoticed residual amount and a timing gap.
Questions
People also ask.
What is the difference between a forex future and a forward?
A future is a standardised exchange-traded contract cleared centrally, while a forward is a private agreement with a bank that can be tailored to any amount and date.
Do businesses have to take delivery of the currency?
No, the great majority of positions are closed by trading the opposite contract before expiry, and the resulting cash gain or loss is used alongside a normal spot conversion.
How much cash is needed to hold a forex futures position?
Only the initial margin set by the exchange, often a low single-digit percentage of notional, plus enough spare liquidity to meet variation margin when prices move.
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