Do forward FX spread bets expire at the spot price?

[Guest RollingTape]

Hi,

I understand that forward FX spread bets will rollover by default and my preference to have them expire has to be communicated in advance. Assuming that I do so, I want to ask what price will be used to settle them. I understand that right now the forward GBP/USD market is a bet on what the rate will be in, say, March 2019 and so it trades at a price that incorporates a discount/premium. However, as we approach March 2019 (and the settling date of this bet) I would expect the price to converge to the actual spot rate, and on the date of settling I would expect there to be no discount/premium anymore as the forces of arbitrage would lead the price to be almost exactly equal to the spot rate on that day. 

Are my expectations correct or is there something I should know?

Thanks!

[Caseynotes]

Hi @Rolling Tape, I'm not totally up on futures and forwards but I think it is the other way round, they will expire by default unless you have checked the rollover option the the settings section from the My IG page. Also I think that they have their own 'settlement' price on expiry and don't use the spot close price. If anyone knows different and/or can add to the above please do.

[Guest RollingTape]

4 hours ago, Caseynotes said:

Hi @Rolling Tape, I'm not totally up on futures and forwards but I think it is the other way round, they will expire by default unless you have checked the rollover option the the settings section from the My IG page. Also I think that they have their own 'settlement' price on expiry and don't use the spot close price. If anyone knows different and/or can add to the above please do.

 

Hi @Caseynotes thank you for the response. Thanks for clarifying expiry/rollover default actions. My main focus here is the price at which they close out at. If they don't close out on the spot price then what do they use? I thought the main point of the Forwards market was to bet on what the price would be in March 2019. If the GBP/USD spot price in March 19 is 1.2808 then I assume there is some mechanism preventing the forwards market from closing out at, say, 1.3011 or something significantly difference, else what's the point of the market? I hope someone else can elaborate further. Thanks again.

[Caseynotes]

Hi @RollingTape, If you were looking to take physical delivery of an asset at a certain price at a certain time in the future you could find a futures contract that would do that but it would be at futures market prices not the spot market prices.

If you look at the spot DFB chart next to the forwards chart below you can see they are the same, price doesn't converge. To trade either as a retail trader you are simply speculating that price will either go up or down, if you are planning a short term position the DFB is more cost effective because the spread is very tight, if you are planning to hold for the longer term the forwards option is more cost effective because there are no overnight charges. When you exit or at expiry it is at the futures market price, if you rollover you are closing and re-opening so you pay the spread over again (though there is a discount).

 

 

[Guest RollingTape]

On 25/09/2018 at 20:18, Caseynotes said:

If you look at the spot DFB chart next to the forwards chart below you can see they are the same, price doesn't converge.

 

 

 

Thanks for the advice @Caseynotes but I'm not sure if I made myself fully clear. I'm talking about convergence on the date that the forward contract is due to expire/rollover. For example the graph that you posted shows the Dec 18 forwards bet, which would expire on the second Friday in December - so I would expect convergence by then, not right now. 

Basically: I expect that the forwards bet set to expire on X date (say December 18) is a bet about what the currency will be in December 18. So right now of course there is a gap between that and the actual currency rate right now (the spot rate graph on the left in your post), because people expect the currency to change in a given direction. But once we get to December 18, that gap should narrow and eventually on X date itself I would expect no gap.

Otherwise - what are we even betting on in the Forwards market? If the March 18 forwards market is a bet about what level the exchange rate will be at on March 15th 2018 (random date), then surely the bet should be settled on March 15th 2018 based on what the rate is at that time - otherwise what drives the settling price?

Thanks again

[rimmy2000]

this is pretty easy to answer. Your bet closes at the prevailing price at the point of closure. If the bet closes in your favour you are credited the gain, however the bet could of course move against you and the loss debited from your account. You can of course close anytime beforehand.

By buying the forward you pay a bit more spread up front but avoid the overnight financing charges, which is different if you bought at stop (DFB) and you incur finance interest each day the bet rolls.

 

So for instance lets say forexX is trading at 1200 to sell and 1205 to buy at spot. On a forward contract this may be, say 1220 to sell and 1225 to buy. 

In three months time the currency may either move upward or downward, and be up or down at the point the bet expires. If it is above the 1205 when you purcased (1300, say) then your gain is the difference.

If it is below the 1205 you bought, say 1180, you are debited the difference (1205-1180)

 

[Caseynotes]

Hi @Rolling Tape, it's an interesting topic not least because most of the educational stuff on futures is about contracts that require physical delivery on a set date rather than leveraged trading through a broker but there are important differences.

The spread difference will always exist between the forwards and spot so the forwards buy/sell price will never converge to the spot price but one component of the forwards pricing is a interest differential between the two currencies and that aspect of the buy/sell price will reduce as the forwards contract nears expiry.

The reason for forwards is simply to provide a more cost efficient market for the long term holders, how long term a trade needs to be will depend on size and expected holding duration in relation to the different costs between spot and forwards.