Currency futures are just a subspecies of forward rate agreements. For large customers there are some limitations.
Let us assume that you are an American company that has signed a contract to sell mobile phones to a Japanese distributor and that your receipts will be in Japanese Yen and that the receipts are due on February 1st, 2011. You do not want to bear the currency risk, as you have calculated your margin with the current exchange rate of 1:119. These are your options:
(a) Hedge the proceeds by selling 6J currency futures. Buy them pack on February 1st, when your customer will pay you in Japanese Yen.
(b) Enter into a forward rate agreement with one of the desks of a large bank with FX operations, to sell the Yen proceeds on February 1st.
(c) Take a loan in Japanese Yen, and swap the proceeds for USD. Payback the loan, when you receive the proceeds.
If you compare the three options, (c) would be the choice, if you are looking for liquidity. It involves both a lopan and an exchange transaction. But it is more complicated to arrange than the other two options.
Using currency futures is the easiest and cheapest solution, but you do not get a perfect hedge. The currency futures only expire in March, but your proceeds are due in the beginning of February, so you actually have a base risk, which is not covered by the hedge. The base risk stems from the difference in the price evolution of 6J and USDJPY, which in turn us influenced byshort term rate policies of the central banks. Currently both central banks follow an approach of quantitative easing, so the risk is very low.
However this risk can be eliminated by entering a forward rate agreement that expires on February 1st and not on March 14, as the currency futures do. If you export sales amount to USD 100 million and the risk is about 0.2% this is an amount of USD 200,000. You might prefer the forward rate agreement, depending on the conditions available.
The liquidity and flexibility of the FOREX spot and forward markets explains that only a small fraction of the volume is traded via currency futures.
Due to lower liquidity, currency futures show larger spikes in times of excitement, see example below. During the flash crash, currency futures diverged about 2% from their value, as the crash raised the fear and the first market participants who had engaged in the Yen carry trade rushed to the exits.
However, I have found volume in currency futures to be relevant, I do trade 6E by using a better volume indicator, and even without the participation of large traders, it does give accurate signals.
The following 4 users say Thank You to Fat Tails for this post:
To me is really important cos is the only way to see the true volume (as traded contracts) in FX market. FX futures volume has grown rapidly in recent years, and accounts for about 7% of the total foreign exchange market volume, according to The Wall Street Journal Europe (5/5/06, p. 20) (wikepedia citation), I think now it should be even more, so, it is statistically significant of about what happens in the whole market.
Take your Pips, go out and Live.
The following user says Thank You to LukeGeniol for this post:
I know traders at several currency funds (spot) and all are telling me they are now watching CME FX product volumes (they all started this within last 12 to 18 months). I definitely can see supply & demand shifts in the CME FX instruments through tracking Cumulative Delta Volume (market order driven order flow).
The following 3 users say Thank You to FulcrumTrader for this post:
Just like I did, I came from forex spot and I strarted to using futures Volume, more than 2 years ago.
That's really does not matter cos forex spot and futures (current contract) have almost the same price and the same movement, so one can trade spot using futures data, like I did before switching to futures, it's onlypersonal choise to trade futures or spot FX.