Question: How to hedge spot forex with futures contracts? | Forex Factory

Options

Permalinks
Print Thread

Similar Threads

Spot Forex vs CFD Forex: Are we really trading Spot? 11 replies

Currency Futures Vs. Spot Forex 1 reply

For lower TF's: Trade Forex or better Futures contracts? 2 replies

Question about licensing for Spot Forex 2 replies

Question: How to hedge spot forex with futures contracts?

  • #1
  • First Post: Oct 12, 2015 6:12am Oct 12, 2015 6:12am
Hello,
I'd appreciate your help here.
There is 1 BUY standard lot size in EURAUD (forex spot market).
How would you hedge it with futures contracts?
Simply SELL EURO + BUY AUSSIE, again 1 standard lot? I doubt so, as I tried it on demo accounts and after few hours I see it doesn't match.
What would be the right calculation?
Can it be 100% hedged or will there be always some differencies?
Thanks for your advice.
My offers: FXCM $4.99/RT, VantageFX $4.30/RT, ICMarkets AU$5.50/RT - PM me!
  • #2
  • Oct 12, 2015 11:56am Oct 12, 2015 11:56am
When you buy one lot of EUR/AUD in spot FX @, for example, 1,5000, you sell 150,000 AUD to buy 100,000 EUR. However when you buy one future contract of EUR you buy $100,000 EUR and when you sell 1 contract of AUD you sell $100,000 AUD. Also those contracts are against the US dollar so because 100,000 eur is not equal 100,000 AUD in term of US dollar you end up having some exposure to the USD

But even if you end up somehow nailing the quantities perfectly you still have problem: A future contract expires at a future set date, so in essence you are betting on the fact that the actualized future price is mispriced. In spot FX you are betting that today's price is mispriced. Time to expiry will affect futures prices, but not spot fx. So, in short, your hedge will not be 100%.
It's not about what you make, it is about what you don't lose
  • #3
  • Oct 12, 2015 12:16pm Oct 12, 2015 12:16pm
More importantly I'm not sure why one would want to hedge a spot position, you either want to be exposed or you don't and if you don't just close the position and reenter whenever you wish too. You will not have to pay swap, extra commission in the future account, you won't have capital tied to 2 positions that will force you to pass on other opportunities and the result will be the same

or maybe I'm missing something , if so I would like to hear your reasoning.
It's not about what you make, it is about what you don't lose
  • #4
  • Oct 12, 2015 12:26pm Oct 12, 2015 12:26pm
Thank you Ace for your post. I understand the first calculation part but not sure about this:

Quoting aceventura69
A future contract expires at a future set date, so in essence you are betting on the fact that the actualized future price is mispriced. In spot FX you are betting that today's price is mispriced. Time to expiry will affect futures prices, but not spot fx. So, in short, your hedge will not be 100%.
Can you explain it on some example?
My offers: FXCM $4.99/RT, VantageFX $4.30/RT, ICMarkets AU$5.50/RT - PM me!
  • #5
  • Oct 12, 2015 12:59pm Oct 12, 2015 12:59pm
go to http://www.cmegroup.com/trading/fx/g...an-dollar.html and check the column with the date and the one named Prior settle. You will notice that the further away the expiry of your future contract is the more the difference of the future with the spot price becomes significant. Inversely the closest you get to expiry, the less this difference will be until you get at the actual day of the expiry which is the only moment where the spot price will equal the future price for certain.

.. So let say you hedge today and the difference between future and spot is 30 pips. You wait until expiry to close your hedge, now the future price=spot. For simplicity's sake lets say the spot price did not move during all this time. you now have a 30 pips loss or gain in your future contract. not a 100% hedge.

The longer your hedge stays in place the less precise it becomes.
It's not about what you make, it is about what you don't lose
  • #6
  • Edited 3:54pm Oct 12, 2015 1:07pm | Edited 3:54pm
I doubt you have EUR/AUD futures.
in that case you would need 2 futures contracts to offset your spot forex: buy AUD/USD contract = 100,000 AUD; sell EUR/USD contract = 125,000 EUR from memory.
EUR = 1.55 AUD, so EUR/USD is worth AUD$ 193,750
that means that 1.25 lots EUR/AUD spot forex is almost perfectly hedged by 2 AUD/USD futures contracts and 1 EUR/USD futures contract.

edit: EUR/AUD futures do exist at cme.com
  • #7
  • Oct 12, 2015 1:16pm Oct 12, 2015 1:16pm
Quoting yonnie
I doubt you have EUR/AUD futures. in that case you would need 2 futures contracts to offset your spot forex: buy AUD/USD contract = 100,000 AUD; sell EUR/USD contract = 125,000 EUR from memory. EUR = 1.55 AUD, so EUR/USD is worth AUD$ 193,750 that means that 2 lots EUR/AUD spot forex is almost perfectly hedged by 2 AUD/USD futures contracts and 1 EUR/USD futures contract.
thank you yonnie.
do you know about some calculator able to do this? if no, is anybody able to create simple table / calculator for some reasonable fee?
thank you.
My offers: FXCM $4.99/RT, VantageFX $4.30/RT, ICMarkets AU$5.50/RT - PM me!
  • #8
  • Oct 12, 2015 1:23pm Oct 12, 2015 1:23pm
Thanks Ace.
I think I got it.
I bought today fxspot contract AUDUSD at .7367 and at the same time sold AUDUSD in futures at .7341.
If I'll wait until the end of expiration, both prices will match, and no matter if it goes up or down, I will be -26 pips in total for sure. Correct?


Quoting aceventura69
go to http://www.cmegroup.com/trading/fx/g...an-dollar.html and check the column with the date and the one named Prior settle. You will notice that the further away the expiry of your future contract is the more the difference of the future with the spot price becomes significant. Inversely the closest you get to expiry, the less this difference will be until you get at the actual day of the expiry which is the only moment where the spot price will equal the future price for certain. .. So let say you hedge today and the difference...
My offers: FXCM $4.99/RT, VantageFX $4.30/RT, ICMarkets AU$5.50/RT - PM me!
  • #9
  • Oct 12, 2015 1:46pm Oct 12, 2015 1:46pm
Quoting milan81
Thanks Ace. I think I got it. I bought today fxspot contract AUDUSD at .7367 and at the same time sold AUDUSD in futures at .7341. If I'll wait until the end of expiration, both prices will match, and no matter if it goes up or down, I will be -26 pips in total for sure. Correct? {quote}
you got the idea

but just to go one step further, in reality it won't be 26 pips exactly because of the swap on the spot side.

In theory, in a arbitrage free context, AUD's rate is higher then USD so you should get a positive swap on your spot position that will balance out the loss on the futur side but retail brokers are skewing swap rate in their favor so you will realize a loss, probably less then 26 pips but still a loss that you will have to factor in your cost of hedging.

same holds true if you sold spot and bought futures. the negative swap should balance out your gain of 26 pips on the future side but again the negative swap rate you have at your retail broker is probably = (probably wrost) then the 26 pips discount you get on the future you bought so you will end up negative also...
It's not about what you make, it is about what you don't lose
  • #10
  • Oct 12, 2015 2:00pm Oct 12, 2015 2:00pm
true.
there is a positive swap in AUDUSUD, e.g. at FXDD +3.14 USD so I guess +0.31 pips / day...there are +/- 60 days to expire Dec15 contract, so +18 pips from SWAP...
but also -26 pips from the hedge. question is how this calculation would look like for EURAUD (where is interest +5.8 USD a day) or even more exotic pairs like USDTRY (+19.7 USD a day). If the diff between spot and Z15 future price would reflect the higher interest?
I'm also curious (and didn't find any info yet) if there would be a way to hedge it with options? I'm familiar with the basics, but that's all. I have no idea about the real costs of buying/selling call/put options and how thiccould be used effectively.

Quoting aceventura69
{quote} you got the idea but just to go one step further, in reality it won't be 26 pips exactly because of the swap on the spot side. In theory, in a arbitrage free context, AUD's rate is higher then USD so you should get a positive swap on your spot position that will balance out the loss on the futur side but retail brokers are skewing swap rate in their favor so you will realize a loss, probably less then 26 pips but still a loss that you will have to factor in your cost of hedging. same holds true if you sold spot and bought futures. the negative...
My offers: FXCM $4.99/RT, VantageFX $4.30/RT, ICMarkets AU$5.50/RT - PM me!
  • #11
  • Oct 12, 2015 4:00pm Oct 12, 2015 4:00pm
as a follow up from my earlier post:

EUR/AUD futures do exist at cme.com and the contract units = 125,000 Euro.
this means that each 1.25 lots of EUR/AUD spot forex will be hedged with 1 futures contract.
  • #12
  • Last Post: Oct 12, 2015 5:13pm Oct 12, 2015 5:13pm
Quoting milan81
true. there is a positive swap in AUDUSUD, e.g. at FXDD +3.14 USD so I guess +0.31 pips / day...there are +/- 60 days to expire Dec15 contract, so +18 pips from SWAP... but also -26 pips from the hedge. question is how this calculation would look like for EURAUD (where is interest +5.8 USD a day) or even more exotic pairs like USDTRY (+19.7 USD a day). If the diff between spot and Z15 future price would reflect the higher interest? {quote}

I find it easier to calculate in %. so for the premium/discount on the future you do: future price/spot price - 1. This will give you % you "earn/lose" holding the future for the number of days left to expiration assuming spot price remains constant. for the swap you can calculate it in a similar way you would with the interest rate parity:

((1+rate of currency you buy * (n/365))/(1+rate of currency you sell * (n/365))) -1 = swap rate
where n = number of days left till expiration

for example i'm with oanda and they pay 1,64% annually for AUD and cost ,3% annually for usd. if I'm buying AUD/USD and there is 60 days till expiration it goes like this:

(1+0,0164*60/365)/(1+0,003*60/365)-1 = gain of 0.22% for 60 days. your swap minus the discount/(premium) will tell you how much you loose on your hedge.

Or if you do not want to bother with all that you can use a swap calculator... some brokers have them for free on their website. the formula above is approximate but should be accurate to around the hundreth of a percent more or less, I think... if anyone finds something wrong with what is a above please advise. I compared with the swap calculator of my broker and it gives the same thing so it should be fine.

But as a rule of thumb your swap will always be wrost then the discount/premium in the future market meaning positive swap will always be less then future premium and negative swap will always be more then the discount you have on the future. If what I just said does not hold true you have an arbitrage opportunity, aka a riskless trade, which, for us retail trader, can be compared to a unicorn: you read about it in books but you never really see one in real life.
It's not about what you make, it is about what you don't lose
0 traders viewing now