How can I trade forex futures?

A Fin24.com user asks: How can I trade foreign currency futures?

The JSE responds: Currency futures can be used as a hedge, trading and speculating tool.

South Africa's foreign currency market is very active and highly traded; with all this activity it is possible to make a profit even when all other markets are down. The rand is the sixth most traded currency in the world.

Besides the usual financial jargon, trading currency futures are relatively simple; the underlying instrument of a currency futures contract is the rate of exchange between one unit of foreign currency and the rand.

Contracts can be purchased in multiples of 1 000 of the foreign underlying currency. The contracts are rand-denominated and settled in cash.

There is never a physical delivery of the currency.

The currency derivatives ensure that only standardised contracts are traded on a fully electronic platform, resulting in guaranteed settlement, a transparent dealing environment and true price discovery.

Hedging example:

Here is a simple exchange of how an investor can use a currency future to hedge against foreign exchange risk. James would like to visit his girlfriend who lives in the United States.

He is prepared to spend $4 000 or R29 600 on his trip (the dollar/rand exchange rate is R7.40/$).

He is worried that the rand will depreciate, so he purchases currency futures contracts now to "lock in" the current exchange rate of R7.50.

One contract is worth $1 000, so he buys four contracts at $4 000 or R30 000.

Fortunately, the contract does not require James to deposit the full amount but rather a small percentage called an initial margin - in this case 20% of the contract's value or R6 000, as well as a brokerage fee negotiated by his broker.

Three months later, when James is set to depart to the US, the rate has jumped considerably to R8.00 to the dollar which will mean that his trip will cost him an extra R2 400 - making those two nights in a top hotel unaffordable.

Fortunately, he has a make a counter profit of R2 400 on the currency futures contracts. James can now sell the currency futures contracts and use the profit to offset the increased cost of the trip.

If you would like to ask specific questions about trading derivatives, contact the JSE's derivatives trading team on 011 520 7475, or email derivativestrading@jse.co.za.

- Fin24.com