Types of Forex Contracts
What are the Different Types of Contracts in Forex?
It is possible to trade currencies in several different ways. Due to the fact that many traders are not aware of the different ways to trade currencies, we have decided to devote this article to talking about the different types of forex contracts.
The following are the types of forex contracts that can be traded in today’s market:
3) Options forex contracts
4) Forex binary options contracts
Spot Forex Contracts
When we mention forex contracts or forex trading, what readily comes to mind is conventional forex trading, which is actually known as spot forex trading. Spot forex trading is defined as a trade in which the trader and the dealer perform currency exchange transactions with both delivery of the asset and financial settlement being done immediately or on the spot. This is the modus operandi of the online foreign exchange market that every trader in this market is familiar with. However, not all currency transactions are done on the spot. Some traders may decide to use other ways of trading forex as we shall see below. You can read more about spot contracts and trade examples here.
Futures Forex Contracts
The futures forex contract differs from the spot forex contract in the timing of the delivery and settlement of the asset, which is done at a future date and not on the spot. In essence, the contractual prices are decided immediately, but delivery of the currency asset and settlement is done in the future. Currency futures are traded on the Chicago Mercantile Exchange and on the Globex platforms.
Another big difference between the futures forex market and the spot forex market is that the futures markets do not operate on a 24 hour basis. There are specific times when the currency contracts can be traded. This is in contrast to the 24 hour daily nature of the spot forex market. Just like in the spot forex market, the terms of the contract make it obligatory for all parties to the deal to exercise the contracts. This feature distinguishes futures forex contracts from the next type of forex contract. The futures markets are tightly regulated by the Commodities and Futures Trading Commission (CFTC). Learn more about futures contracts here.
Forex Options Contracts
Currency options are traded on the Chicago Mercantile Exchange, the Philadelphia Stock Exchange and the International Securities Exchange and can be defined as derivative instruments in which the owner of the contract has the right to exercise the option by exchanging one currency asset for another at a predetermined exchange rate and at a future date. However, the terms of this contract does not make it mandatory for the trader to exercise the option at that date. In essence, the trader can choose not to exercise it if he does not find it profitable to do so.
For this contract, there must be a pre-agreed strike (the exchange rate), an expiry date (maximum of three months) and the contract is fragmented into trade sizes which can only be purchased in multiples of that trade size. Currency options are used as hedges against unstable exchange rates. Large corporations who do business that requires exchange of large volumes of money in transactions where a minute shift in the exchange rate can translate into a difference of hundreds of thousands of dollars, like to use currency options in this manner. One reason why there aren’t many individual traders in this market is because the margin requirements are large. In the US, the maximum allowable margin is 1:20, which means that a trader must be able to muster $5,000 as margin for a single $100,000 options contract trade.
Forex Binary Options
These are a relatively new forex contract type, which evolved with the deregulation of the binary options market in 2008. Forex binary options allow traders to trade currency pairs as all or none options/binary options. This presents one of the safest ways to trade forex contracts and can be traded by even traders without much experience. Contract sizes can be as small as $25, and margin requirements are not stringent. They are traded on the platforms of binary options brokers.
There are a few other ways that currencies can be traded. These are:
b) Currency Swaps
Exchange traded funds (ETFs_ are usually funds that track the performance of a basket of instruments. As such, an ETF can actually be a forex ETF in which the fund tracks a basket of currencies, or can be a composite basket which tracks a set of currency assets, commodities and stocks. Such forex ETFs can be traded on the stock markets using a retail broker.
Currency swaps are forex agreements undertaken by two parties to exchange or swap the principal and/or interest payments on a loan in one currency for an equivalent amount of a net present value loan in another currency.
These are the various types of forex contracts that are available in the markets today.