The currency sector offers the most liquid and active markets of any sector. For retail traders, it also offers the most variety in accessing them. Some love futures with the security of segregation, while other prefer the added leverage of spot forex. In recent years both markets have changed. Electronic trading has allowed forex futures to add liquidity exponentially while also developing more products and different sized contracts, and recent regulatory changes have made the spot forex world a lot less scary while maintaining its unique flexibility. Futures asked the experts to provide pros and cons for trading futures vs. spot forex...
Spot forex is better by Michael Boutros
Currency futures are better by Dave Schulz & Scott Brusso
Spot forex is better By Michael Boutros
When considering which market to actively trade, investors have a host of options from which to choose. As it pertains to the forex market, both futures and spot have their benefits for traders attempting to tap into the estimated $3.98 trillion daily FX volume. Closer examinations of the two options reveal benefits and flexibility for long/short-term, intra-day traders in the spot FX market.
Spot FX provides traders with highly leveraged accounts that allow them to trade multiple times their account size. While this obviously can work against the trader, leverage allows the average investor to effectively trade standard-sized lots while holding just a fraction the actual value traded. Whereas a typical FX brokerage will require the trader to hold just 2% of the value of the contract, futures traders must hold the CME Group's (or other FX futures exchanges') required margin, which on a standard lot of EUR/USD would be more than $5,000. Comparatively, the margin required to hold one standard-lot of euro in the spot market would be approximately $2,800. Smaller contracts make it more appealing for new traders as the margin required for a single micro-lot can be as low as $20.
Everyone trades differently. Whether a person is an active scalper or a longer-term fundamental trader, trading the proper size position becomes key when implementing various trading strategies. Spot FX brokerages allow for much more flexibility as many now offer mini-lots and even micro-lots to smaller traders looking to participate in FX markets. The flexibility to trade various sized contracts also inherently gives investors more versatility with regard to their strategy and how much risk they would want to take on. The availability to trade smaller lots means an investor can participate in the market with less capital at risk while still being able to take advantage of intra-day market volatility.
While spot FX markets are open virtually 24 hours during the week, futures markets are closed one hour each day. Although markets are usually at their quietest during the break, it does mean traders will not be able to open/close positions or react to any unforeseen market moves. Once the futures market comes back online, there also may be gaps and/or slippage on orders as market liquidity spikes suddenly.
An important aspect of trading any market is transaction costs. While futures traders often are hitting the bid or lifting the offer and are charged a commission and clearing and exchange fees on every trade, spot FX traders usually pay only the spread. Spreads can widen dramatically under illiquid conditions that tend to happen more often in the futures market.
Duration of the trade is another key aspect to consider when choosing the correct market. Execution is the single most important factor that can affect a trader's performance directly. Spot FX brokerages have fast and accurate execution, especially in light of the new ECNs (electronic communication network) now offered by various brokerages that match buyers and sellers at lightning speed. Although futures markets may provide traders more transparency in this regard, orders often can take a few seconds before confirmation of the trade is received by the trader as the order bounces from the broker to the exchange.
Rollovers are a process by which the settlement date of an open position is extended via the simultaneous closing and opening of a new value-dated contract. This process is needed because traders would be required to take delivery of the currency two days after transaction date. Another main function of rollovers is to take into account the different yields each currency offers. For example, if a trader is long a higher-yielding currency, he will receive a designated amount based on the interest rate differential of the counter-currency; whereas if a trader is long the lower-yielding currency in the pair, the position is charged on the rollover. In spot, this transition is seamless to the trader, and the exact amount of each roll is accessible on the trading platform or account history at the same time on every trading day. In the futures market, the value of the contract takes into account the differentials, and the actual exchange rate will reflect the diverging yields. It is not always as easy for a futures trader to identify the actual amount he is paying/gaining on a specific transaction, as the difference between the spot rate and futures rate dwindles as the futures contract reaches expiry.
This leads us to yet another important point for longer-term traders. As a futures contract reaches expiry, liquidity on that particular contact starts to dry up, requiring the futures trader to roll his position (exiting his position in the expiring contract and establishing it in the next delivery month, usually with a calendar spread). Spot traders never experience this problem. Traders can hold the same position for hours, months, days or even years without having to jump into a new, more active contract. All the while, the rollovers are accessible and readily available with most reputable brokerages.
This highlights the final point. While futures traders will often argue the benefits of transparency in their respective market, a closer look reveals the importance of choosing the correct broker. While CME Group offers much more transparency for participants, does this really outweigh the other benefits? Choosing an FX brokerage should not be taken lightly and, with the proper research and due-diligence, traders can remain confident that they are doing business with the right firm. Some traders are not keen on having the broker trade against them, but there always is someone on the other side of a given trade; whether it is the broker or another trader is irrelevant. So long as the rates supplied are in line with broader markets, the counter-trader should be of no concern to a trader. More important is the reputation and track record of a broker. Most reputable FX brokerages are governed by a regulator that ensures fair business practices with clients. In the United States, this agency is the National Futures Association (NFA), while offshore brokerages are governed by their own respective agencies.
There are benefits for traders utilizing spot or futures FX. When deciding which market is best, you need to match your style of trading and risk tolerance to the platform that best serves you. For the average active trader looking to take advantage of market fluctuations with minimal transaction costs and ultra-flexibility with account and trade sizes, the spot market offers the most suitable trading environment.
Michael Boutros is currency analyst for DailyFX.com. He specializes in the FX markets. Contact him at email@example.com.
Currency futures are better By Dave Schulz & Scott Brusso
There is no question that the FX market continues to see tremendous growth. The continued uncertainty and market volatility caused by macroeconomic events such as the Eurozone sovereign debt crisis and the U.S. quantitative easing policy have been contributing factors to the more recent spikes in volumes. But over the longer term, the FX market has seen growth due in part to the marketplace's global nature, as well as the evolution of technology and electronic trading that allows a wide breadth of customers to participate.
The Bank for International Settlements (BIS) triennial survey provides the most comprehensive information on the size of global FX markets and gives the best view into global trends. According to the most recent study, the global FX market grew 20% from April 2007 to April 2010. In contrast, CME Group FX volumes grew 94% during that same time period. Similarly, looking back to 2001, the numbers show a three-fold increase in the global FX market. Currency futures' growth from 2001 to 2010 show a staggering 18-fold increase. Additionally, the report shows the overall FX options market decreased 2%, while the CME Group FX options market increased 226%.
While we do not make predictions on the future growth of asset classes, the expansion of international trade and global investment certainly will keep FX at the forefront of investors' minds because it is a key in cross-border trading across all asset classes. So why has the exchange-traded FX market seen such staggering numbers compared to the underlying cash market? The catalysts for growth are clear: Deep liquidity, competitive pricing, diverse customers, speed of execution and risk mitigation.
Today, CME is the largest regulated FX marketplace with more than $125 billion in daily liquidity. In 2001, we averaged $10 billion a day. It is this deep liquidity that is crucial during volatile market conditions and enables traders to get in and out of markets quickly and easily.
In addition, FX options on CME Globex are the single largest pure electronic liquidity pool for FX options, whether exchange-traded or over-the-counter (OTC).
Level playing field
Whether you are a large institution or an individual trader, everyone is on equal footing when it comes to pricing currency futures. Best price wins, it is as simple as that — something that is not always the case in the fragmented OTC FX market where market participants' credit ratings determine available executable prices. Outside of FX futures, there is very little transparency with trade data in OTC FX. As a result, market participants can look only to Commodity Futures Trading Commission data. Because of the global financial crisis and impending regulation, the market is now realizing how tremendously important transparency of market data is alongside central counterparty clearing.
The futures markets' equal access creates a diverse trading community in addition to access to a diverse FX product suite. Trading activity among market participants outside traditional commercial banks, especially proprietary firms, hedge funds, pension funds, mutual funds and insurance companies, is contributing to growth in the FX markets. Unlike some cash markets, these different customer groups all trade in one central trading system, which offers the same tradable prices with complete anonymity in all bids and offers.
There are 54 futures and 31 options contracts based on major and emerging-market currencies, such as the Brazilian real, Chinese renminbi, Korean won and the Turkish lira. Market participants have the ability to mitigate risk with currency futures' longer dated currencies and benefit from the significant margin offsets available. As noted, the options quickly outpaced the OTC market last year as hedging tools, and customers also have benefited from trading the underlying futures of these options within the same platform. Furthermore, currency futures have seen strength with all 20 different currency pairs, while the spot market tends to provide strength in major currencies only.
There has been a big jump in the cross-currency pairs. FX cross rates hit record volumes in June, particularly the Swiss franc, which was up 261%, indicating the market's concern over the euro.
E-micro FX contracts are one-tenth the size of standard FX futures with one-tenth the risk exposure. The contracts allow for exact offsets with corresponding standard-size FX futures.
CME's currency futures are traded on the CME Globex electronic trading system. These trades are executed and confirmed instantly, and traders can access Globex through approximately 1,000 direct connections in more than 85 countries and foreign territories, providing fast, efficient trading on all our products.
Safety and security
Since the 2008 crisis, market participants have a greater appreciation of the counterparty and credit risk in cash markets. The importance of a guarantor and clearing method are key to today's FX markets. FX futures offer backing at clearinghouses and risk is shared among clearing members, protecting investors in the case of a default, guaranteeing every transaction and virtually eliminating counterparty risk.
The recent growth illustrates the need and desire for counterparty risk mitigation and the central counterparty clearing model that exchange trading offers. CME Group's perfect record of never having a default or loss of customer funds resulting from a failure of a clearing firm is exactly what market participants need when mitigating their risk.
The steady, strong growth of volume in FX and currency products at futures exchanges resulted from an increased desire, both on the sell-side and the buy-side, to mitigate counterparty risk.
Currency futures have very competitive pricing, deep pools of liquidity, a diverse range of counterparties across all segments of the FX market and benefit from the diversity of product range at the exchange — such as fixed income and equities, alongside agricultural and commodity trades. These intriguing benefits have enabled currency futures to become an attractive alternative to spot FX.
Scott Brusso and Dave Schulz are directors for FX products at CME Group.