What is the difference between trading currency futures and spot FX?

By Matt Lee AAA
A:

The forex market is a very large market with many different features, advantages and pitfalls. Forex investors may engage in currency futures as well as trade in the spot forex market. The difference between these two investment options is very subtle, but worth noting.

A currency futures contract is a legally binding contract that obligates the two parties involved to trade a particular amount of a currency pair at a predetermined price (the stated exchange rate) at some point in the future. Assuming that the seller does not prematurely close out the position, he or she can either own the currency at the time the future is written, or may "gamble" that the currency will be cheaper in the spot market some time before the settlement date.

With the spot FX, the underlying currencies are physically exchanged following the settlement date. In general, any spot market involves the actual exchange of the underlying asset; this is most common in commodities markets. For example, whenever someone goes to a bank to exchange currencies, that person is participating in the forex spot market.

The main difference between currency futures and spot FX is when the trading price is determined and when the physical exchange of the currency pair takes place. With currency futures, the price is determined when the contract is signed and the currency pair is exchanged on the delivery date, which is usually some time in the distant future. In the spot FX, the price is also determined at the point of trade, but the physical exchange of the currency pair takes place right at the point of trade or within a short period of time thereafter. However, it is important to note that most participants in the futures markets are speculators who usually close out their positions before the date of settlement and, therefore, most contracts do not tend to last until the date of delivery.

For further reading, see Getting Started In Foreign Exchange Futures, Getting Started In Forex Options and Using Options Tools To Trade Foreign-Exchange Spot.

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