DERIVATIVES TRADING - CURRENCY FUTURES
LYNDEN REABOW
FX TRADER
PSG ONLINE
Wednesday, 27th June 2012
INTRODUCTION
• The foreign exchange market operates 24 hours a day.
• Markets open in the Far East, and as Tokyo winds
down, European markets open followed by the US, and
as the US reaches its close, the Far Eastern markets
open their doors once again.
• Turnover in the FX Spot market has increased from $5
Billion in 1977 to $3.2 Trillion a day!
• In South Africa the currency futures market only began
in 2007, total value traded in 2007 was R1.5 billion.
• In 2011 R100 billion traded locally.
INTRODUCTION
Graph 1: Value of currency futures traded in SA 2007-2012
Currency Futures Value Traded (CUM)
R 350,000,000,000
R 300,000,000,000
R 250,000,000,000
R 200,000,000,000
Value Traded
R 150,000,000,000
R 100,000,000,000
R 50,000,000,000
R0
2007
2008
2009
2010
2011
2012
INTRODUCTION
• The large size of the FX market is important as it
contributes towards:
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Continuous and full liquidity
Around the clock trading
Around the globe trading
High efficiency
Price stability
• The US dollar is the most widely traded currency and
accounts for 40 – 45 per cent of all spot forex trading.
WHY PROFESSIONALS TRADE FOREX
• The forex market has established itself as an additional
asset class.
• There is no correlation with other asset classes, thus
you are likely to protect your portfolio through
diversification.
• Forex market exhibits a market that offers, size,
consequent liquidity, accessibility, leverage and
popularity.
• The forex market is 24 times the average daily turnover
of global equity markets (USD130 billion).
• A new breed of “day trader” has found a fertile new
playground.
FOREIGN EXCHANGE ANALYSIS
• The forex investment product is very simple but the
factors determining the prices are highly complex.
• Primary analysis techniques used by forex market
traders:
– Fundamental analysis 41%
– Technical analysis 26%
– Flow Information 16%
– Quantitative analysis 17%
IMPORTANCE OF ECONOMIC DATA
• Fundamental analysts follow the consistent releases of
macroeconomic data of the countries whose currencies
they trade.
• Technical analysts evaluate market prices based on
historical price patterns.
• Important economic data influencing the currency
markets are:
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Employment data
Consumer confidence data
Manufacturing / production data
Dollar Index (measures the performance of the dollar against a
weighted basket of other currencies)
– Vix Index (measures the implied volatility of the S&P Index)
– US 10 Year Treasury (if yields decrease is shows investors
buying US treasuries i.e. risk aversion, running for safety)
DIFFERENT CURRENCIES
• Major Currencies
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USD
GBP
EURO
JPY
CHF
• Minor Currencies
– Singapore Dollar, New Zealand Dollar, Indian Rupee.
• Exotic Currencies
– Indonesian Rupiah, Thai Baht, Hong Kong Dollar, Malaysian
Ringgit.
• Emerging Market Currencies
– South African Rand
– Russian Rouble
– Brazilian Real
DIFFERENT CURRENCIES
• Emerging markets currencies are lumped together and
any occurrence affecting one emerging market currency
may spread like wild fire through all emerging market
currencies.
• Investors in emerging market currencies must therefore
always keep a tab on generic developments in other
emerging markets.
• South Africa is also known as one of the “commodity
countries”. Developments regarding the prices of metals
such as gold, platinum and silver, and occurrences like
bull or bear markets in commodities generally impact on
the South African rand.
WHO ARE CURRENCY TRADERS
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Investment funds
Asset managers
Hedge funds
Multinational corporations
Banks
Trading advisors / money managers
Individual “retail” speculators i.e. YOU!
• Speculators do not consider taking or making
delivery of foreign exchange.
WHAT IS A CURRENCY FUTURE
• Currency futures are standardised contracts that are
traded on the JSE’s Currency Derivatives Trading
Platform.
• Traders choose to either buy (long) or sell (short) a
specific currency pair. For example, if you think the US
Dollar is going to strengthen relative to the South
African Rand, you would go long/buy the USDZAR
contract. By doing this you are automatically buying
Dollars and selling the Rand at the same time.
• Alternatively, you might think that the Euro is
overvalued relative to the South African Rand (and
therefore should weaken) in which case you would
short/sell the EURZAR contract. By doing this you are
automatically selling Euros and buying the Rand at the
same time.
CURRENCIES TRADED ON THE JSE
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Dollar/Rand
Euro/Rand
Pound/Rand
Aussie Dollar/Rand
Yen/Rand
Canadian Dollar/Rand
Swiss Franc/Rand
One can also trade synthetic crosses for example,
EUR/USD, GBP/USD and GBP/EUR. Synthetic trades
are becoming increasingly popular amongst investors
as the margin requirements are considerably less than
Rand bases crosses.
CURRENCY FUTURE DETAILS
• Contract size
– 1 contract exposes you to 1,000 of the foreign underlying
currency e.g. US$1000 or €1000 or ₤1000
• Standardised contracts
– Expire in March, June, September and December.
• Price Movement 1 c = R10 Profit or Loss per contract
• Cash Settled on expiry in Rands.
• Contracts quoted in SA Rand to 4 decimal places (On the
futures exchanges one unit is not called a “pip” but a “tick”).
• No physical delivery of foreign currency.
• Gearing/Leverage, can be as high as 20 times, we limit it to
10 times.
• Contract can be closed or rolled at the end of the contract
expiry to the next contract period.
JSE ADAPTNG TO NEW DEMANDS
• In a effort to increase liquidity and boost the currency
future market in SA, as of 11th June 2012, the JSE has
introduced a system where by all day trades and
synthetic trades will only pay JSE clearing and
settlement fees on one leg of the trade.
• Trading costs are halved on day trades.
• PSG has also dropped the min brokerage fee of R100,
it thus possible to now trade 1 contract and only pay
R18 brokerage.
HOW CURRENCY FUTURES WORK
• In order to open the futures position an investor must deposit the
necessary initial margin with the JSE.
– Initial margin is 2 times the JSE margin. 50% of this amount will go to initial
margin and the other 50% will go to retained margin, used as a buffer for MTM
movements.
– Marked-to-Market (MTM) – The daily revaluation of each open position by the
exchange at the close of each business day.
– Variation margin – the daily process through which the unrealised profits and
losses are processed into the client’s cash account by the exchange through
the MTM process.
• Leverage (or “gearing”) simply means to trade with margin.
The value of currencies transactions engaged is higher than the
amount a trader or investor has on margin.
• Leverage is a double-edged sword. Leveraged positions can lead
to large gains if the exchange rate between two currencies moves
as anticipated, but conversely will cause large losses if the
exchange rate moves in the opposite direction. The concept of
being “wiped out” is not just a theoretical possibility, but a real one.
WHERE TRADING OCCURS
• The spot currency market is “over-the-counter” which means it is
“decentralised” consisting of a multiplicity of closely cooperating
“markets”.
– Spot currency prices, at any given moment, vary from dealer to
dealer or bank to bank or dealing desk to dealing desk or
market maker to market maker. There is not one global “price”
for any currency pair at any given moment in time.
• Currency futures on the other hand trade on “organized
exchanges” i.e. the JSE's Currency Derivatives Trading Platform.
• On the exchanges, trading takes place publicly in a centralised
location.
– Hours, trading practices and other matters are regulated by the
JSE.
– Margin payments, daily marking to market, and cash
settlements through a central clearing house and guaranteed
by the JSE.
SPOT PRICE VS. FUTURE PRICE
• The difference between the spot price and the futures
prices is as a result of “The forward points”.
• The forward points are a function of the interest rate
differential between the two domestic countries.
• The forward points should offset, or neutralise the
interest rate differential between the two currencies and
prevent any risk-free arbitrage opportunities.
CALCULATING THE FUTURE PRICE
• To calculate the forward points, the following elements
play a role:
– The deal date
– The maturity (or settlement) date
– The overnight interest rates of the applicable
countries (currencies)
CALCULATING THE FUTURE PRICE
• For example:
– Maturity date is 82 days forward (27 June 2012 to 17
Sep 2012).
– The spot exchange rate USDZAR: 8.20
– South African JIBAR = 5.595% (0.5595)
– US 3 month Treasury = 0.1% (0.0100)
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Points are added when the interest rate of the base currency (USD) is the lower
one (0.1% vs. 5.595%), since the base currency should trade at a forward
premium.
The future rate would thus be 8.20000 + 0.1234 = 8.3234
SPECULATIVE TRADING
• Normal future trade – Dollar Bear
– Sizwe feels that in the current economic environment there is a
lot of positive sentiment and he feels that we will start seeing a
more risk on* environment coming our way and consequently
feels that the dollar is overvalued and should depreciate in the
near future.
– On day 1 the spot rate is trading at 8.2000 and the future is at
8.3234 . Sizwe sells 100 Sep 12 USDZAR contracts @ 8.3234
Margin per contract is R340.00 per contract. (Remember
margin must be multiplied by 2). Brokerage is R18.00 per
contract (Brokerage is paid to open the position and again
when the position is closed).
– Client pays to PSG R69 800 (R68 000 +R 1 800)
Initial margin earns interest on deposit at SAFEX rates.
*A risk on environment causes investors to shy away from safe haven assets like the USD,
JPY and CHF. Money flow should then favour risky assets. The Rand is a regarded as a risk
asset being an emerging market currency.
SPECULATIVE TRADING
• On day 4 the spot rate is trading at 8.00 and the future is at 8.1234
• Sizwe buys the 100 Sep USDZAR contracts back at 8.1234
- Gross Profit = R20,000
- Total Brokerage = R3,600 (R1,800 X 2)
- Net Profit = R16,400
• The initial capital outlay of R68,000 has returned a profit of
R20,000. A return of 30% during the period in which the Rand only
weakened by 2.4%
If this was day trade (i.e. opened and closed on the same day)
brokerage would only have been paid on the one leg.
Total brokerage would then been R 1,800
SPECULATIVE TRADING
Cash Flow Table
Day 1 Trade Date
Day 2
Day 3
Day 4
Initial Margin
R -68 000
R 0.00
R 0.00
R 68 000
Brokerage
R -1 800
Trade Price
R 8.3234
R 8.2500
R 8.1500
R 8.2300
MTM Price
R 8.2500
R 8.1500
R 8.2300
R8.1234 (CLOSED AT)
Profit/(Loss) for
the day
8.3234-8.2500
8.2500-8.1500
8.1500-8.2300
8.2300-8.1234
x R10.00/pip
0.7340
1.0000
-0.8000
1.0700
x100
73.40
100.00
-80.00
106.60
x number of
contracts (100)
R 7 340
R 10 000
R -8 000
R 10 660
Net Cash flow for
the day
R 5 540
R 10 000
R -8 000
R 8 860
R -1 800
SPECULATIVE TRADING - SYNTHETIC
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Rationale:
The markets continue to show much risk. The U.S. isn't great but doing OK, the back drop in the Eurozone is still in
a mess. Greece’s economic future and future in the eurozone remains uncertain.
Investors still favour running to the safety of the U.S. dollar on mounting concerns of the instability in the Spanish
and broader European banking sector, amid a lack of immediate policy responses from European leaders.
The markets have been downgrading their views on China, as its economy slows and get sets for a soft landing.
To arrest market fears, proactive measures are needed, and investors need to be convinced that austerity measures
will be implemented and adhered to, unfortunately, they seem nowhere in sight. This suggests that risky assets are
likely to trade erratically at best, with a bias.
In South Africa we cannot trade foreign crosses directly. We have to trade two crosses vs. the Rand which collapse
to form a synthetic trade.
Advantage
- Exposure to foreign crosses
- Margins net off
- Investor get great exposure for less margin
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One day1 the spot EURUSD is trade at 1.3302
Spot EURZAR is trading at 10.0315 and the future is trading at 10.0774
Spot USDZAR is trading at 7.5425 and the future is trading at 7.5540
Thus the spot synthetic is equivalent to
= 1.3300
And the future synthetic is equivalent to
= 1.3340
Investor A sells 100 Sep 12 EURZAR contracts @ 10.0774
Investor A buys 100 Sep 12 USDZAR contracts @ 7.5400
SPECULATIVE TRADING - SYNTHETIC
•
These two trades collapse to form the synthetic short euro/long dollar at a synthetic futures rate of 1.3340 and a
implied synthetic spot of 1.3300
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Margin on the individual positions
Sells 100 Sep 12 EURZAR contracts = R 40 000
Buys 100 Sep 12 USDZAR contracts = R 37 500
However as this is a synthetic trade, the JSE will net off margin.
Net margin on the synthetic is now only R 10 500
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Brokerage is R18.00 per contract (Brokerage is only paid on the one leg as this is a synthetic trade)
Client pays to PSG R12 300 (R10 500 +R 1 800)
Initial margin earns interest on deposit at SAFEX rates
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6 months later the spot EURUSD is trading at 1.2501
Spot EURZAR is trading at 10.5908 and the future is trading at 10.6270
Spot USDZAR is trading at 8.4726 and the future is trading at 8.4937
Thus the spot synthetic is equivalent to
= 1.2500
And the future synthetic is equivalent to
= 1.2512
•
Gross Profit = R 37 080
Total Brokerage = R3 600.00 (R 1 800 X 2)
Net Profit = R 33 480
The initial capital outlay of R10 500 has returned a profit of R 37 080
A return of 353% during the period in which the EURUSD only weakened by 6%
SPECULATIVE TRADING - SYNTHETIC
PNL TABLE
SELL EURZAR
Direction Contracts Spot Price Fut Price Exposure ZAR Value Total Bro (ZAR)
Open Position
Close Position
Sell
Buy
100
100
R 10.03
R 10.59
R 10.08 R 100 000 R 1 003 150
R 10.63 R 100 000 R 1 059 080
R 1 800
R0
End Value
R -1 059 080
Initial Value
R 1 003 150
Less Brokerage
R -1 800
Profit (ZAR)
R -57 730
End Value
R 847 260
Initial Value
R -754 250
Less Brokerage
R -1 800
Profit (ZAR)
R 91 210
Net PNL
R 33 480
BUY USDZAR
Direction Contracts Spot Price Fut Price Exposure ZAR Value Total Bro (ZAR)
Open Position
Close Position
Buy
Sell
100
100
R 7.54
R 8.47
R 7.55
R 8.49
R 100 000 R 754 250
R 100 000 R 847 260
R 1 800
R0
HEDGE TRADING – EXAMPLE 1
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Client A would like to send money abroad as part of his 4 million Rand off shore allowance. He
has decided to use half and send 2 million Rand abroad.
With this money he intends to invest in equities and property abroad .
Client A has taken a look at the current spot price of 8.2000 and feels that this is an ok level and
he wishes to do the spot conversion.
He is concerned that the Rand will weaken from its current levels, and he will get less foreign
currency for his Rand as a result by the time he does the actual conversion in a month’s time.
Solution: Hedge the currency with the use of a future and lock in a rate.
How does it work?
Buy the USDZAR future contract, this will give him the right to buy USD/sell Rand at a specified
rate and a specified date.
One day 1 Client A buys 244 Sep 12 USDZAR at 8.3224
In 1 month when the client does the spot conversion to convert Rands into Dollars at his local
bank to send abroad, the Rand as expected, has weakened.
He has lost R0.30c by the Rand moving from 8.2000 to 8.5000.
However on his future hedge he has made R0.30c
USDZAR contract was bought at 8.3224 on the future and the future is now currently trading at
8.6224
This has translated into a net profit on the hedge of R 65 001 which has offset the loss on the
spot transaction effectively locking in the original spot rate of 8.2000
HEDGE TRADING – EXAMPLE 1
Cash Flow Table
Day 1 Trade Date
Day 2
Day 3
Day 4
Initial Margin
R -165 920
R 0.00
R 0.00
R 165 920
Brokerage
R -4 392
Trade Price
R 8.3200
R 8.4300
R 8.5700
R 8.4700
MTM Price
R 8.4300
R 8.5700
R 8.4700
R8.6224 (CLOSED AT)
Profit/(Loss) for
the day
8.3200-8.4300
8.4300-8.5700
8.5700-8.4700
8.4700-8.6224
x R10.00/pip
x100
1.1000
110.00
1.4000
140.00
-1.0000
-100.00
1.5200
152.40
x number of
contracts (244)
R 26 840
R 34 160
R -24 400
R 37 185.60
Net Cash flow for
the day
R 22 448
R 34 160
R -24 400
R 32 793.60
R -4 392
HEDGE TRADING – EXAMPLE 2
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Rationale
AngloGold’s income is derived from the performance of Dollar denominated gold prices. The primary driver of gold prices
is Dollar strength / weakness. A negative correlation exists between the share price of AngloGold and the Dollar. As the
Dollar strengthens Anglo’s share price decreases. The risks therefore to the holders of Anglo shares are fluctuations in
the USDZAR. The solution then is to hedge out the investor’s foreign currency exposure. If this is done, the investor then
has the exposure to the performance of Anglo as a company without the currency risk.
Futures
1,000 ANG shares @ R306 = R306, 000 exposure / 8.3846 USDZAR
= $36 495 exposure
= long 36 USDZAR future contracts
RISKS OF TRADING CURRENCIES
• Currency futures are geared instruments.
– With this leverage/gearing you are able to make large profits from small initial
layouts of capital. However the opposite is also true. Should the trade move
against you, you could incur large losses as a result of the leverage/gearing.
• There is a risk that you may lose more money than you
initially invested.
• The most important thing to remember is that not every
trade will be a successful trade resulting in profits.
• With every trade you should also have a target price/profit
target in mind. Be strict and diligent. Don’t trade on emotion;
trade on fundamentals, a strategy and logic with some
common sense.
• It is very tempting to ride a trade into profit and stay in the
trade looking for larger gains. This can go wrong and you
may well ride the trade all the way back into losses.
ADVANTAGES
• A known currency rate can be traded and locked in.
• There is no need to hold the futures contract till expiry, the
contract can be closed or traded out at anytime.
• Due to the fact that the contracts trade on the JSE, investors
enjoy a liquid market with dedicated market makers making
competitive prices with tight spreads.
• Futures are geared products, which mean currency traders do
not have to deposit cash to cover the full value of the position.
• Importers and exporters can dynamically hedge their currency
risk far more efficiently using futures due to the ease of entering
and exiting futures positions and the low cost per trade.
• The daily mark-to-market process allows clients the ability to
track their profit or loss situation and to adjust their portfolio
accordingly.
• Once the position has been closed out, all settlement occurs in
Rand.
ADVANTAGES OF PSG
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PSG is a well-known, independent and respected financial services
provider in South Africa. PSG is regulated by the financial services board
of South Africa as well as being a member of the Johannesburg Stock
Exchange.
PSG traders are highly skilled and are approved by the JSE to trade on
the South African Futures exchange.
PSG is able offer a competitive trading brokerage of R18 per contract,
which includes the JSE clearing and settlement fee. The spreads / prices
that you receive are the same as those that are trading on the JSE. PSG
does not add to or adjust the contract spreads / prices.
There is no monthly account fee.
You will receive daily market research, market commentary, trader’s
views, trading ranges and trade ideas to help you make informed and
educated investment decisions.
Clearly that is wealth simplified, but if all of that doesn’t convince you, then
we should tell you that there is one thing we wouldn’t trade… The fact that
we were voted stockbroker of the year 2011**
**As voted for by Business Day Investors Monthly.
HOW DO I START
• Visit the Currency Futures page on the PSG Online
website – click here
• Call PSG Online on 0860 PSG PSG / 774 774 or email
info@psgonline.co.za
• Our Currency Futures team will arrange for the opening
of your account.
• You can register online – click here
Contact us
Thank you
Lynden Reabow: Sales Trader
lynden.reabow@psgonline.co.za
021 799 8136
078 756 28 27
Ockert van Niekerk: Head of Trading
Ockert.vanniekerk@psgonline.co.za
021 799 8111
Heidi van Niekerk: Compliance Officer
Heidi.vanniekerk@psgonline.co.za
021 799 8087