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3.1 Currency Futures - Definition Futures contract Futures markets were innovated to overcome the limitations of forwards. A futures contract is an agreement made through an organized exchange to buy or sell a fixed amount of a commodity or a financial asset on a future date at an agreed price. Simply, futures are standardized forward contracts that are traded on an exchange. The clearing corporation associated with the exchange guarantees settlement of these trades. A trader, who buys futures contracts generally takes a long position and the one, who sells futures, takes a short position. The words buy and sell are figurative only because no money or underlying asset changes hand, between buyer and seller, when the deal is executed. Features of futures contract In futures market, exchange decides all the contract terms of the contract other than price. Accordingly, futures contracts have following features:  Contract between two parties through Exchange  Centralised trading platform i.e. Exchange  Price discovery through free interaction of buyers and sellers  Margins are payable by both the parties  Expiry date decided today (standardized)  Quantity decided today (standardized lot size) Currency Futures means a standardised foreign exchange derivative contract traded on a recognized stock exchange to buy or sell one currency against another on a specified future date, at a price specified on the date of contract, but does not include a forward contract. Exchanges has launched its currency futures trading platform in August 2008, in separate segment called currency derivative segment. Initially, Currency futures on USD-INR was introduced for trading and from February 2010, the currency futures on EUR-INR, GBP- INR and JPY-INR was introduced. Further in 2018, Cross Currency Futures contracts on EUR-USD, GBP-USD and USD-JPY are also introduced. Exchange traded currency 48 derivatives context, cross currency derivatives means derivatives on currency pair not involving Indian rupee. 3.1.1 Futures Terminologies Let us understand various terms in the currency futures market. Underlying Asset: Currency future is derivatives, and its value is derived from value/price of certain underlying asset. In this case the underlying can be the exchange rate in Indian Rupees for US Dollars, Euro, Pound Sterling, Japanese Yen. Further for cross currency futures the underlying can be the exchange rate in US Dollars for Euro and Pound Sterling and exchange rate in Japanese Yen for US Dollars. Spot price/rate: The price at which the underlying asset (currency pairs) trades in the spot market Futures price: The current price of the specified futures contract. The future price can be more or less than price of spot price. However, on expiry date future price of the contract converge with the spot prices. Quotation: It specifies how the price is quoted for future contract. For e.g. for USDINR future the price quotation is the exchange rate in Indian Rupees for one US Dollars and for JPYINR it is the exchange rate in Indian Rupees for 100 Japanese Yen. Contract Cycle: It is a period over which a contract trade. The currency futures contracts on the SEBI recognized exchanges can be weekly, monthly and quarterly. In case of monthly contract, contract maturing in immediate month is called near month contract, contract expiring in next month is called mid-month contract and subsequent month contract is called far month contract. These contracts can extend up to one year. There can be different contract cycles based on underlying. For e.g. INR based currency futures have weekly and monthly contracts and cross currency futures may have only monthly contracts. Expiry date: Also called last trading day or maturity date of contract. It is the day on which trading ceases in the contract. For all monthly currency futures contract expiry date is two working days prior to the last business day of the expiry month at 12:30 PM. On expiry date the trading in contract ceases at 12:30 pm and not on regular trading time of 5:00 pm or 7:30 pm. Tick Size: It is minimum move allowed in the price quotations. The minimum trading increment or price differential at which traders are able to enter bids and offers is called as tick size. For example, if tick size for USDINR futures is Rs. 0.0025, the price entered by buyer and seller can be 74.9975, 75.0000, 75.0025 in multiple of Rs.0.0025. Contract size/Lot Size: Futures contracts are traded in lots. Contract size specifies the amount of asset that has to be delivered for a single contract. This is also called as lot size. 49 Trading is always happened in multiple of lot size. For e.g. lot size for USDINR contract is 1000 USD. Contract Value: To arrive at contract value, we have to multiply the price with contract multiplier or lot size or contract size. Trading Hours: Time during which trading is allowed on Exchange trading platform. Exchange currently have different market timings for contract involving Indian rupee and contract not involving Indian rupee. Further, on contract expiry day, the specific currency futures and option contract stop trading earlier than normal trading hours i.e. 12:30 pm. Base Price: Base price generally act as reference price for trading for start of the day. Generally, on the first day of trading (i.e. on introduction) of contract, it would be the theoretical futures price. The base price of the contracts on subsequent trading days would be the daily settlement price of the futures contracts as computed by Clearing Corporation. Price Band: The price range (maximum and minimum price) for the day within which contract can be traded for that day. Generally, specify +/-% to base price. In many derivatives contract there is no price band for contracts, in such cases dummy operating range is set to avoid erroneous order entry at non-genuine price. Mark to Market (MTM): The positions in the futures contracts for each member are marked-to-market to the daily settlement price of the futures contracts at the end of each trade day. The exchange/CC collects these margins (MTM margins) from the loss-making participants and pays to the gainers on day-to-day basis. Daily Settlement Price (DSP): It is required mainly for MTM settlement. The settlement price is weighted average futures price (VWAP) of the trades generally in the last 30 minute of trading (i.e. close price), if close price is not available then theoretical price. Final Settlement Price (FSP): All open positions on the last trading day of the currency futures contract shall be marked to the final settlement price for the relevant futures contract and shall be settled on final settlement day. Final settlement price / rate is mainly derived from the underlying/spot market. Final Settlement: Final settlement can be cash settled or physical settled. In case of cash settlement only the profit and loss resulting from positions shall be paid / received from the participants. In case of physical settlement, participants have to physically give/take delivery of stocks/underlying asset to settle the open transactions instead of settling them with cash. Currently, all exchange traded currency futures and option contracts are cash settled in Indian rupee. Open Interest: An open interest is the total number of contracts outstanding (yet to be settled) for an underlying asset. It is important to understand that number of long futures 50 as well as number of short futures is equal to the Open Interest. This is because total number of long futures will always be equal to total number of short futures. Only one side of contracts is considered while calculating/mentioning open interest. The level of open interest indicates depth in the market. Positions in derivatives market As a market participant, you will always deal with certain terms like long, short and open positions in the market. Let us understand the meanings of commonly used terms: Long position Outstanding/ unsettled buy position in a contract is called “Long Position”. For instance, if Mr. X buys 5 contracts on USDINR futures then he would be long on 5 contracts on USDINR futures. If Mr. Y buys 4 contracts on EURUSD futures, then he would be long on 4 contracts on EURUSD. Short Position Outstanding/ unsettled sell position in a contract is called “Short Position”. For instance, if Mr. X sells 5 contracts on USDINR futures then he would be short on 5 contracts on USDINR futures. If Mr. Y sells 4 contracts on EURUSD futures, then he would be short on 4 contracts on EURUSD. Open position Outstanding/ unsettled either long (buy) or short (sell) position in various derivative contracts is called “Open Position.” For instance, if Mr. X shorts say 5 contracts on USDINR futures and buys say 3 contracts on EURUSD futures, he is said to be having open position, which is equal to short on 5 contracts of USDINR and long on 3 contracts of EURUSD futures. If next day, he sells 2 contracts EURUSD futures contracts of same maturity, his open position would be short on 5 contracts of USDINR futures contracts and long on 1 contract of EURUSD futures contract. Opening a position Opening a position means either buying or selling a contract, which increases client’s open position (long or short). Closing a position Closing a position means either buying or selling a contract, which essentially results in reduction of client’s open position (long or short). A client is said to be closed a position if he sells a contract which he had bought before or he buys a contract which he had sold earlier.