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Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

E-Micro Forex Futures

What it is:

E-micro forex futures are currency futures contracts that are a 10th the size of a standard futures contract

How it works (Example):

Forex futures are financial contracts giving the buyer an obligation to purchase a certain currency (and the seller an obligation to sell that currency) at a set price at a future point in time.

Let’s say you manufacture jewelry in the United States but plan to open a plant in Japan. You will need to pay the operating costs of that plant in yen next year

Now, when the utility bills and payroll are due, you could just convert American dollars to yen when you need to do so. However, exchange rates fluctuate, and it might take far more dollars to buy the number of yen you need in one month versus another month. This makes buying a futures contract for yen a plausible idea.

By buying a currency futures contract, you essentially lock in the price of those yen now. This eliminates the risk of a falling dollar. However, it also creates the risk that the price you paid for those yen could look relatively expensive later if exchange rates don’t work in your favor. You might end up overpaying or (hopefully) underpaying for the yen depending on where currency prices actually are when you need the currency.

Either way, the futures contracts are standardized, meaning they specify the underlying commodity's quality, quantity, and delivery so that the prices mean the same thing to everyone in the market. The contracts are usually $100,000 in size. Micro forex futures are no different, except that they are much smaller—$10,000.

This can be helpful if you’re a small company, or don’t need to hedge that much currency, or are an individual investor who just wants to play the currency markets. And if you come out on the losing end of the trade, you’ll have only done so with $10,000 rather than $100,000.

Since 2009, six kinds of e-micro forex futures contracts have traded:

Euro/U.S. dollar

U.S. dollar/Japanese yen

British pound/U.S. dollar

U.S. dollar/Canadian dollar

Australian dollar/U.S. dollar

U.S. dollar/Swiss franc

There are several futures exchanges. Common ones include The New York Mercantile Exchange, the Chicago Board of Trade, the Chicago Mercantile Exchange, the Chicago Board of Options Exchange, the Chicago Climate Futures Exchange, the Kansas City Board of Trade, and the Minneapolis Grain Exchange. Micro forex futures trade on the Chicago Mercantile Exchange’s electronic trading platform, called Globex.

Why it Matters:

E-micro forex futures are smaller contracts designed to make currency hedging more accessible to smaller investors. But smaller contract size and smaller margin requirements do not necessarily mean smaller risk.

The e-micro forex futures market is regulated by the Commodity Futures Trading Commission (CFTC), but futures trading is nonetheless a zero-sum game: If somebody makes $1 million, somebody else loses $1 million. The downside is unlimited. Because futures contracts can be purchased on margin, meaning that the investor can buy a contract with a partial loan from his broker, traders have an incredible amount of leverage with which to trade thousands or millions of dollars’ worth of contracts with very little of his own money. Further, futures contracts require daily settlement, meaning that if the futures contract bought on margin is out of the money on a given day, the contract holder must settle the shortfall that day. The unpredictable price swings for the underlying commodities and the ability to use margins makes trading futures a risky proposition that takes a tremendous amount of skill, knowledge and risk tolerance.