What is a currency future?

A currency future, also called an FX future or foreign exchange future, is a derivative product because its value derives from the underlying asset. In the case of a USD/EUR future, the value of the contract is derived from the exchange rate.

One party to the agreement agrees to buy (longs) the currency in question at the specified exchange rate and the other agrees to sell (shorts) it at the expiry date. Traders make a profit or loss depending on the difference between the pre-agreed exchange rate and the real, effective exchange rate on the date of expiration.

In reality, futures contracts do not exist directly between the two parties (i.e. the buyer and the seller). Instead, each party signs a contract with a clearinghouse, which reduces the risk of default on the contract to nearly zero.

Currency futures are traded on exchanges and they are highly regulated financial products. The counterparty holding the contract on expiry date is legally bound to take delivery of the currency involved at the given exchange rate. 

Currency futures are commonly used to hedge against currency risk. For example, if a forex trader has an open position on a spot currency rate, he may use a currency futures contract to hedge. In order to trade currency futures, you will need to have a margin account at a broker. 

This type of financial derivative is used by traders and investors to manage risks associated with currency fluctuations, allowing them to lock in a price for future currency transactions. Similarly to all types of investments, currency futures have both advantages and disadvantages. 

Advantages:

• Hedging: one of the biggest advantages of currency futures is that they allow investors and businesses to hedge against currency risk. By locking in a future exchange rate, they can protect themselves against unexpected changes in currency values. 
• Regulated: currency futures are highly regulated products traded on government regulated markets.
• Liquidity: currency futures are traded on organized exchanges, which ensures liquidity and transparency in the market. 
• Leverage: currency futures contracts offer high leverage, which means that investors can control a large amount of currency with a relatively small investment.
• Low counterparty risk: the futures exchange's clearing house guarantees transactions. Although there is a possibility of the clearinghouse defaulting, this risk is very low.

Disadvantages: 

• Risk: currency futures contracts are a form of derivative, which means that they carry inherent risk. If the exchange rate moves in the opposite direction to the futures contract, investors can lose money. 
• Margin requirements: currency futures contracts require an initial margin deposit, which can be a barrier to entry for smaller investors or businesses. 
• Time-limited: currency futures contracts are time-limited, which means that investors and businesses need to accurately predict when they will need to exchange currency in the future. 

If you are a beginner, we recommend you open a demo account at a forex broker and trade with virtual money at first until you develop your own trading strategy. Most of the brokers in our top list of the best forex brokers in the world  provide a demo account free of charge. Alternatively, you can check out our ranking of the best futures brokers. 

For instance, a company that intends to purchase goods from another country six months from now could use currency futures to secure the exchange rate at which the payment will be made, thus mitigating the risks of currency fluctuations that could influence the price of the goods.

Let's say a U.S. company plans to import goods from Europe in six months' time and wants to protect themselves against the risk of exchange rate fluctuations.  The company decides to enter into a currency futures contract to buy €500,000 in six months' time at a fixed exchange rate of 1 EUR = 1.15 USD. 

The futures contract requires an initial margin deposit of 5% of the total contract value. At the time of entering into the contract, the company would need to deposit an initial margin of 5% of €500,000, which is €25,000. Six months later, the euro has appreciated against the dollar, and the new exchange rate is 1 EUR = 1.2 USD. Normally, the company would buy €500,000 for $600,000 (€500,000 x 1.2), but because they entered into a futures contract at a fixed exchange rate of 1 EUR = 1.15 USD, they only have to pay $575,000 (€500,000 x 1.15). 

As a result of the futures contract, the company has saved $25,000.

Overall, entering into a currency futures contract helps the company to manage their currency risk and protect themselves against unexpected fluctuations in the exchange rate.

How do you buy currency futures?

To buy currency futures, you will need to open a margin account with a brokerage firm.

What are the benefits of currency futures?

Some of the main benefits of currency futures is that they are highly regulated, provide price transparency, are traded on highly liquid markets and can be traded with leverage.

Who regulates currency futures?

Currency futures are regulated by government regulatory bodies in the countries where the futures are traded. In the United States, for example, the Commodity Futures Trading Commission (CFTC) is responsible for regulating futures trading, including currency futures.