Interest on contract?

[Pavlec]

Hi,

I have a quick question, do you pay interest when you buy a futures contract?
I mean if you need 500$ for an ES contract do you pay all the interest on borrowed money?

Thank you

 

[LiveTradingZone]

No you do not pay interest.

 

[Rhody Trader]

I have a quick question, do you pay interest when you buy a futures contract?
I mean if you need 500$ for an ES contract do you pay all the interest on borrowed money?

You aren't borrowing any money, so there's nothing on which to pay interest.

That said, there is interest factored into the pricing of futures contract.

 

[mephistos]

You aren't borrowing any money, so there's nothing on which to pay interest.

That said, there is interest factored into the pricing of futures contract.

Hello,

Thanks for your post. I'm a bit confused with this matter. I can't understand why is an "factoring in" of interest if there is no lending nor borrowing. Probably you will advise me to get done with your book before asking silly questions :innocent:
But I'm trying to find a quick explanation on this matter as I'm looking at the AUD/USD futures, and it seems the longer the expiry date the lower the rate for the pair. I understand this is because the market is getting bullish on the USD or at least expects a deeper correction on the AUD; but I can't figure out what are the implications of interest rate differentials between the two currencies in this case.

 

[Rhody Trader]

For a currency futures contract, the interest rate differential between the two currencies in question is what creates the difference between current spot and the quoted futures price. It's the no free lunch rule. Using your example, AUD is the higher yielding currency. If we borrow USD, convert to AUD, and invest we'll make a spread. Of course there's the risk that AUD/USD falls and wipes out our interest profits. If we went short the futures we could lock in the exchange rate to remove that currency risk. Then we'd have the "free lunch" of the interest rate spread. Since there's no free lunch in the markets, though, the price of the futures contract is lowered to offset that interest rate spread.

 

[mephistos]

For a currency futures contract, the interest rate differential between the two currencies in question is what creates the difference between current spot and the quoted futures price. It's the no free lunch rule. Using your example, AUD is the higher yielding currency. If we borrow USD, convert to AUD, and invest we'll make a spread. Of course there's the risk that AUD/USD falls and wipes out our interest profits. If we went short the futures we could lock in the exchange rate to remove that currency risk. Then we'd have the "free lunch" of the interest rate spread. Since there's no free lunch in the markets, though, the price of the futures contract is lowered to offset that interest rate spread.

Yes I guess I understand.
But I could also short the AUD on the spot market and have the free lunch, as in the spot market if I'm short the AUD I will RECEIVE interest on that position I suppose, as the interest rate differential is in my favour. Of course I bear the risk of the AUD going even higher, but still it seems a better option as on the futures market there is no interest rate to gain and I would bear the risk of the AUD going higher as well.
Would you agree that the spot market is generally a better option to speculate on currencies?

Thankfully,

Mephistos

 

[Rhody Trader]

But I could also short the AUD on the spot market and have the free lunch, as in the spot market if I'm short the AUD I will RECEIVE interest on that position I suppose, as the interest rate differential is in my favour.

This is incorrect. Because the AUD is the higher rate currency, if you short it you'd pay more in interest, not receive more.

Of course I bear the risk of the AUD going even higher, but still it seems a better option as on the futures market there is no interest rate to gain and I would bear the risk of the AUD going higher as well.
Would you agree that the spot market is generally a better option to speculate on currencies?

From the perspective of the interest carry, holding a futures contract and holding a spot position of the same size will see very, very close performance. There might be some variation if interest rates move, but that's about it. Whether spot or futures are better comes down to other factors not related to prices and interest.

 

[lamog7]

Since there's no free lunch in the markets, though, the price of the futures contract is lowered to offset that interest rate spread.

Where do you live? In another planet? Bernanke has offered a free lunch to the markets and nothing of the short you describe holds entirely. People keep on borrowing USD at maybe 1.5% , exchanging it for AUD, putting the money in a CD to make a 5% differential in a year, while due to these actions the exchange rate keeps on going up.

Contrary to what you were taught or think you know, there is a free lunch in the market for those that have access to free money created by the FED or are willing to do large amount carry trades.

 

[Martinghoul]

Hahahaha!!! Carry trades are "free money"!!! Love it!!! Best of luck with that.

 

[mephistos]

What he meants is that there is no SURE free lunch. I.e, that you can't do it and use a futures contract as a insurance policy to make it 100% safe.
But I'm really wondering if it's not possible to do it with a leveraged spot contract. then you can hedge exchange rate fluctuations "for free" and limit your gains to the interest payments.
What I don't understand is why there are such discrepancies in the futures markets. If you look up
you'll find that the exchange rate really drops heavily, for the longer contracts. Or is this due to the fact that the market is starting to antecipate falls in the exchange rate for the pair?
http://www.barchart.com/commodityfutures/Australian_Dollar_Futures/A6M11

 

[mephistos]

This is incorrect. Because the AUD is the higher rate currency, if you short it you'd pay more in interest, not receive more.

Ok,

I'm quoting you again, cause I missed this before.
I was really thinking that it was other way round. That we would get inetrest when we short the most interest bearing currency and pay when we are long that currency. I got it wrong i guess. Therefiore my previous post makes no sense at all, cause if you hedge in the spot you'll have to pay interest anyway.
In between I must say I'm ashamed of being so ignorant yet and fierce that I'm making my best to learn.

best to you all

 

[moksha99]

I think we are talking about 2 diff things
1) Carry trade borrow in USD or yen at 1% or something and put in AUD @ 5%
Not risk free... at maturity exchange rate might have gone against you more than the 4% differential

2) SPOT / Futures
If SPOT is lower than Future then Buy SPOT and Sell Future at expiry they must settle at same price
Can be applied to
Stock - Single stock futures SSF ( USA)
Currency SPOT - Currency futures

Sounds like free money but it is not
Until expiry you have holding or carry cost of the SPOT/ stock + brokerage = Futures price.. so no free lunch!
Additional risks with Currency is unlike Stock, currency is not traded on regulated exchange! ( although Currency futures are) so there is no guarantee that the statement "at expiry they must settle at same price " holds true. as SPOT currency is at a mercy of your broker who is market maker mostly.


Any way has anybody researched Exchange for physical EFP traded on One Chicago exchange?
Buy stock , Sell future
Sell Stock, Buy future