CME Group foreign currency products

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CME Group is the largest and most active foreign currency (FX) futures and futures options market in the world, with a daily notional trading value of $80 billion (as of year-end 2007)[1].

2007 Volume

CME Group foreign currency product daily volume averaged 569,000 contracts in 2007 versus 453,000 in 2006, an increase of 26%. The five most active FX contracts were the euro, Canadian dollar, Swiss franc, British pound and Japanese yen[2].

Overview of CME Group FX Markets

CME Group FX futures are standardized, exchange-traded contracts to buy or sell a currency at a specific price some time in the future, commonly three months or more. As of December 2007 CME Group offered trading in 41 individual FX futures contracts and 31 FX options products covering 19 major country currencies, including currency pairs and emerging market currencies.

More than 90 percent of all CME Group FX trading is transacted electronically on the CME Globex electronic trading platform virtually 24 hours a day, every business day.


Clearing

Regulated by the Commodity Futures Trading Commission, CME Group's FX customers deal anonymously in a fully transparent market, where large and small customers have equal access to the same prices and same deep pool of liquidity. A central clearing mechanism, CME Clearing, settles all trades and acts as the counterparty between buyers and sellers, thus virtually guaranteeing the creditworthiness of every transaction. The existence of a futures exchange clearing house and other features differentiate CME Group FX from the cash over-the-counter market used by institutions and over-the-counter retail forex products used by individual investors.

FXMarketSpace

FXMarketSpace, a 50-50 joint venture between CME and Reuters established in 2006, takes OTC FX trading and guarantees to a new level. FXMarketSpace is the first centrally cleared OTC foreign exchange (FX) platform to combine the central counterparty model and clearing function of CME Group and fully anonymous execution (features not present in the traditional over-the-counter forex market) with Reuters' global distribution network and straight-through processing capability.


FX Futures and Options Users

Since CME foreign currencies were introduced on the CME's International Monetary Market Division in 1972, the scope of users has changed. Once a market used heavily by those speculating on the movement of a particular currency, users now are primarily institutional and global.

According to CME Group, users of these financial instruments include both buy- and sell-side investors, including commercial and investment banks, hedge funds, Commodity Trading Advisors, proprietary trading firms, currency overlay managers, and individual investors who use FX instruments in a variety of risk-averse and opportunistic strategies.

Individual CME Group FX Products

*Indicates top five contracts based on volume in 2007

CME features American style options exercise on its currency options products as well as European style options exercise on five products: the British pound, Canadian dollar, Euro FX, Japanese yen and Swiss franc futures contracts. The majority of the volume (as of 2007 year-end) is in the American style options.

CME Group Currency Cross Rates

Currency cross-rate futures reflect the value of one currency in relation to another. CME Group cross rate futures contracts are quoted as the minimum fluctuation currency per the trading unit currency. For example: Euro/Yen is quoted as yen per Euro, where the futures contract calls for delivery of 125,000 Euro (the trading unit), and daily settlement variation is in yen (minimum fluctuation currency).

Currency cross-rate futures are physically delivered at expiration. Exercised options contracts are settled by the delivery of futures contracts.


FX specifications -- contract size, delivery, minimum tick size, etc. -- vary by contract.

FX Quotes

CME Group FX products are quoted in terms of U.S. dollars per unit of the other currency being traded. For example, quotes would be given in U.S. dollars per euro or U.S. dollars per Japanese yen.

The FX spot market uses direct quotes in some instances – with euros, British pounds, Australian dollars and others – but more commonly uses an indirect quote convention. Indirect quotes are given in terms of a foreign currency per U.S. dollar, such as Japanese yen per U.S. dollar.

Market participants who are accustomed to trading FX spot markets but want to know how to express CME futures prices as spot equivalents can use the exchange's Foreign Exchange (FX) E-quivalents program, a Web-based application.[3]

Free real-time quotes are available,[4] and flash quotes, which are delayed at least ten minutes, are also available at no cost for CME Group FX products.

History

The growth of CME, now CME Group, can be attributed in part to economic events which led to the creation of FX futures in 1972, particularly the death of the Bretton Woods Agreement, which in 1945 had established a narrow band of fluctuations between European currencies and the U.S. dollar. The Agreement specified that the U.S. dollar would be tied to the price of gold, with its value set at 1/35th an ounce of gold. All other nations’ currencies were fixed in relation to the dollar’s gold content. Variations were limited to only plus or minus one percent. The breakdown of Bretton Woods eventually led to the concept for and creation of CME foreign currency futures.

These fixed exchange rate bands, established through the Bretton Woods Agreement remained in place until August 15, 1971, when President Richard M. Nixon dropped the U.S. dollar convertibility to gold and devalued the dollar to 1/38th an ounce of gold. His actions led to an irreversible breakdown of the system of fixed exchange rates and opened the door to the free float of major world currencies. It had one additional effect in that it gave rise to the necessity for a public futures market in which to hedge currency fluctuation risk.

The concept of a market in currency itself was not new. A forward currency bank market, known as the Interbank Market, an outgrowth of the Bretton Woods Agreement, was in existence. But as its name implied, the Interbank Market was limited to banks acting for themselves or their global institutional clients. An individual, regardless of his standing, purpose or wealth, or businesses that did not measure up to the “international commercial” standards demanded by the banks, were barred from participation.

In a well-publicized story, when Milton Friedman attempted to go short the British pound in 1971, banks refused him the right to do so on the basis that “Friedman did not have the necessary commercial interest to deal in foreign exchange.”

Having long before become a disciple of the free market principles espoused by Milton Friedman, the idea for an FX futures market that would determine currency values on the basis of supply and demand seemed obvious to then-CME Chairman Leo Melamed and other key CME officials. Many of experts in foreign exchange warned, however, that futures markets were suited for traditional agricultural products and little else. They could never be applied to the sophisticated maneuvers utilized by world banks and financiers.

Melamed, together with then-CME President Everette B. Harris, met with Milton Friedman for breakfast in New York in November 1971. Melamed posed the rationale behind foreign currency futures and asked for Friedman's opinion. Friedman agreed wholeheartedly with the concept. “Its success," he said, "depends only upon how fast the Bretton Woods Agreement is suspended.” In his opinion that might not happen for a year or two. Upon further discussion, the CME chairman asked Friedman whether he would consider putting his opinion in writing.

Friedman agreed, and for $7,500 wrote a feasibility study on “The Need for a Futures Market in Currency.” His 11-page paper, which was submitted to the CME in December of 1971, gave the concept for currency futures academic credibility they needed to go forward.

Friedman’s words were succinct and to the point:

"Changes in the international financial structure will create a great expansion in the demand for foreign cover...It is highly desirable that this demand be met by as broad, as deep, as resilient a futures market in foreign currencies as possible in order to facilitate foreign trade and investment...Such a wider market is almost certain to develop in response to the demand. The major open question is where. The U.S. is a natural place and it is very much in the interests of the U.S. that it should develop here."

The end to Bretton Woods came much faster than Friedman had thought. In July 1971 President Nixon closed the gold window and effectively ended the fixed exchange rate regime. It sent markets into turmoil, unleashing economic and political reverberations.

On May 16, 1972, the Chicago Mercantile Exchange's International Monetary Market Division (IMM) launched seven currency futures contracts: British pounds, Canadian dollars, Deutsche marks, French francs, Japanese yen, Mexican pesos, and Swiss francs.[5][6]

Online Educational Programs about CME Group FX Products

Basic:

  • CME offers a two basic online programs on FX -- "CME Group FX for the Individual Trader"[7] and "Trading CME FX Futures" [8] that answer questions regarding the differences between FX futures and cash forex and overview various fundamentals of FX, the technical approach and other basics for beginners.

Somewhat more advanced:

  • A free online course -- "Dynamics of Foreign Exchange" -– offers a more in-depth understanding of the fundamentals of the FX market and trading CME Group FX futures.

Advanced:

News

  • Volatility-based quoting of 5 FX options for early 2008. On Nov. 1, 2007, CME Group announced plans to offer volatility-based quoting on six of its FX options on futures contracts: Euro FX, British pound, Japanese yen, Canadian dollar, Swiss franc and Australian dollar. This quoting convention enables "delta-neutral" trading, which virtually eliminates the execution risk inherent to trading in live premium by quoting FX options in volatility terms. The exchange indicated that volatility-based quoting is expected to launch in Q1 2008 and will be available exclusively for FX options trading on the CME Globex electronic platform.[9]


  • Round-the-clock trading for FX options. On Sept. 6, 2007, CME Group announced that as of Sept. 10, 2007, it would begin offering virtually 24-hour-a-day electronic trading for weekly FX options on futures with American-style expiration. The weekly options, all of which trade against the U.S. dollar, include the euro FX, Japanese yen, British pound, Swiss franc, Canadian dollar and Australian dollar.[10]

Other CME Group Product Areas


References

  1. "CME Group Posts Seventh Consecutive Year of Record Volume on a Combined Basis as Total Volume Approached 2.8 Billion Contracts; Exchange Daily Volume Averaged 11.0 Million Contracts per Day, Up 28 Percent,”1/2/08. CME Group.
  2. "CME Group Posts Seventh Consecutive Year of Record Volume on a Combined Basis as Total Volume Approached 2.8 Billion Contracts; Exchange Daily Volume Averaged 11.0 Million Contracts per Day, Up 28 Percent,”1/2/08. CME Group.
  3. E-quivalents. Chicago Mercantile Exchange.
  4. FX quotes. Chicago Mercantile Exchange.
  5. "The Birth of FX Futures". Leo Melamed, Chicago Mercantile Exchange web site.
  6. "Podcast: Birth of FX Futures””. CME Group.
  7. CME Group FX for the Individual Trader. CME Group.
  8. "Trading CME FX Futures”. CME Group.
  9. CME Group to Offer Volatility-Based Quoting Convention for FX Options. Yahoo!Finance.
  10. "CME Group to Offer Electronic Trading of Weekly FX Options". Chicago Mercantile Exchange.


Resources

CME Group Web site