FX Futures: How Currency Trading Revolutionized Finance


Financial futures today represent 90% of the global futures trade, with currency futures being the first financial futures product to be traded 45 years ago.

Today’s financial world would be very different without the creation of currency futures in the early 1970s. Launched in 1972, they ushered in a new era of free market ideas and activity.

As chairman of the Chicago Mercantile Exchange, Leo Melamed has sought to diversify beyond meat futures and other stock exchange agricultural contracts.

Against the backdrop were the changes taking place in the global economy, which was growing again more than 20 years after World War II. Back then, economists from the major world powers met annually to set their exchange rates against the US dollar, known as the Bretton Woods Agreement. But global economic growth, increased competition between countries, and the faster dissemination of news and information have started to render these annual ministerial meetings obsolete. When President Richard Nixon took the United States off the gold standard, valuations changed.

“It was a constant change,” says Melamed. “Constant change is what we do as an exchange … For me, this juxtaposition of the old Bretton Woods model versus the new world we were living in was responded to by an exchange that had the ability to adapt to change as it is happening at all times. “

“Currencies had the latitude to float in wider bands relative to each other and therefore their value was potentially subject to greater uncertainty,” said Paul Houston, global head of foreign exchange for CME Group. “What a great innovation to design a monetary future that could set the value of the price an investor would pay or receive for a currency.”

Alan Bush, senior financial economist at ADM Investor Services, says looking at fluctuations in exchange rates gives clues to a country’s economic health.

“Exchange rates are a very good indicator of the political and economic situation of the country and are likely to move forward. It is a good barometer of the future economic prospects of any country,” said Bush. .

According to Houston, the importance of foreign exchange markets can be seen in facilitating international trade and investment by enabling currency conversion. Forward currency contracts provide an efficient mechanism for hedging and also trading currencies for investment purposes in their own right.

A new type of futures market

In the early 1970s, Melamed was convinced that a currency futures contract would be the answer to the changes taking place. He just needed to convince the others.

“I realized that what I thought was almost heretical,” he says, noting that until then all futures have been based on agricultural commodities.

To do this, he met with University of Chicago economist Milton Friedman in late 1971, who, for $ 7,500, wrote a feasibility study on currency futures. Melamed used this document to convince the majority of CME’s board members to approve currency futures. He also met with government officials to explain the plan with Friedman’s paper in hand.

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Leo Melamed and Milton Friedman on the floors of the Chicago Mercantile Exchange

“I thought the idea was so wonderful, it was so big, the government had to understand what I was doing or else I might have enemies out there that I didn’t need to have,” he says. he.

On May 16, 1972, the CME listed seven currency futures: the Canadian dollar, the British pound, the German deutschmark, the Japanese yen, the French franc, the Mexican peso and the Italian lira.

On that first trading day, 333 contracts changed hands and that year 144,336 contracts were traded. From there, the CME listed the Treasury bill futures and looked for other financial instruments to quote.

The fact that the world’s major currencies trade in one place also made sense.

“The virtues of centralized and widely accessible market places have been recognized since medieval times. That is why ‘the market’ is still at the center of many towns,” says Harold de Boer, Managing Director of Transtrend BV.

To make financial contracts more attractive, the International Monetary Market (IMM) was created. An IMM seat only allowed the holder to negotiate financial contracts and created the illusion that this was separate from the rest of the exchange. These seats were cheaper, which drew young traders into financial pits. It worked, and after several years the financial contracts became well established.

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First day of listing at IMM.

So why start with currencies and not with interest rates or stocks? Currencies were all in the news back then, so it made sense to go with what was most important in people’s minds. They were deliverable, a requirement at the time. Cash-settled contracts were not approved until the early 1980s and led to the listing of futures on the Standard & Poor’s 500 stock index.

45 years old and it matters

Today, 59 currency futures and 30 options on currency futures are offered by CME Group. The forex market has flourished over the past 45 years, and recent legislative changes, such as the Dodd-Frank Act, have helped increase activity in the market. The open interest in currency futures is setting records as more and more users hold positions on the stock exchange.

More recent trends in currency trading show an increase in interest in trading emerging market currencies, such as the Chinese Renminbi, South African Rand and Russian Ruble. Houston says CME will continue to focus on attracting a wider range of users. Recent initiatives include changing the minimum tick increment, reducing block sizes, and launching monthly volatility-quoted currency futures and options.

“The goal is to provide more choice to market participants, but without disrupting the successful franchise we have today,” he says.

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New technology, same fundamentals

Users are also finding more ways to access the market. Technological change began to accelerate in the 1990s with the introduction of electronic commerce and the Globex system.

“The electronic age has made accessibility to centralized markets even more efficient and comprehensive,” says de Boer.

Just as Melamed saw the speed of news and information flow accelerate in the 1970s, trading technology increased the speed with which news is delivered today.

“Political and economic news is reflected almost instantly in exchange rates and futures prices,” Bush said. “Order execution and reported executions, with the advent of e-commerce, you get everything much faster now.”

Although technology keeps changing, the fundamentals of the forex market have not changed. Bush says the futures markets remain the company’s primary hedging tool to reduce the risk of exchange rate losses.

Written by Debbie Carlson. Read more from the author here.

Read more stories like this on OpenMarkets. And for trader tools and resources, visit: https://activetrader.cmegroup.com

(This article is sponsored and produced by CME Group, which is solely responsible for its content.)

Read more stories like this on OpenMarkets. And for trader tools and resources, visit: https://activetrader.cmegroup.com


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