Replicating EUR/USD Spot FX and Forwards with CME FX Futures

CME Group offers 53 FX futures contracts on 40 different currency pairs across all major currencies, including cross rates, and a wide range of emerging market currencies. Both monthly and quarterly expiries are available, with IMM-dated exposures that cover the first six months of the FX forward curve. These products can be traded both as outrights and as spreads and so can be effectively used to replicate a variety of OTC FX positions. Furthermore, because FX futures on major currencies are physically delivered, they are highly correlated with the underlying OTC FX markets and thus provide market participants with a simple, cost-efficient, and standardized complement for OTC FX spot and FX forwards.

The most active and frequently traded of all the listed FX contracts is the CME EUR/USD FX futures contract. During 2020, open interest (OI) in EUR/USD futures grew to an all-time high, with levels reaching over $121 billion in September. Towards the end of the year the contract also reached a new all-time record of 306 large open interest holders (LOIH) which helped to underpin strong overall year on year (YoY) growth in EUR/USD volumes and OI, with 2020 average daily volume (ADV) up 5.3% YoY and average OI up 17% YoY. 

Into 2021, volumes continued to grow, with January up 19% compared to a year prior. Asset managers, in particular, have helped to drive this growth; as of February 23, 2021 asset managers were holding the largest ever net long position in CME EUR/USD FX futures.¹

From a total cost analysis (TCA) point of view, the reduction in the minimum price increment (MPI) in non-consecutive calendar spreads from 0.5 to 0.2 in EUR/USD futures that was delivered in 2019 has contributed to reduced roll costs and has resulted in increased roll efficiency.

In the December 2020 quarterly roll, greater roll efficiency was evidenced by increased OI transference, with average OI rolled up 7% vs. the prior four rolls (86% vs. 79%). Improvements were also seen in the cost of execution with EUR/USD being quoted at the reduced MPI of 0.2 for approximately 99% of regular trading hours during the main roll period.

In addition to these cost improvements, the nature of the futures central limit order book (CLOB) in providing differentiated liquidity (more on this below) and enabling passive trading also resonates positively in the context of end user TCA. In previous studies,² customers have reported the ability to trade at mid, 35% of the time on average, helping to avoid paying even the narrowest of spreads available via another platform or aggregator.

Whilst the majority of volumes in FX futures remain executed via the CLOB, it is worth also noting that ‘ex pit’ trading mechanisms provide an important method of execution for customers who are more familiar with trading on a disclosed basis in the OTC market or who are trading a ‘large’ order more suited to bilateral negotiation. In Q1 2021, the minimum price increments for block and EFRP trades in EUR/USD (as well as other G10 pairs) was reduced to 0.1 pip, enabling the potential for tighter pricing for both outrights and spread trades executed via these mechanisms in order to deliver enhanced price discovery and reduced cost of execution.³

In addition to the other features mentioned in the opening paragraph of this article, the pricing available via FX futures can often be somewhat different to the pricing available in the OTC market. This differential is driven by several factors, including a very diverse ecosystem of participants that all trade on an anonymous, credit agnostic, and all-to-all basis.

CME’s FX Market Profile tool⁴ combines data from two primary venues of price discovery (CME’s FX futures contracts and OTC Spot FX on EBS Market) to provide market participants with a unique view on the structure of the FX market. This data allows market professionals to ensure they are using the complementary liquidity pools of FX futures and OTC Spot FX to trade in the optimal way depending on the time of day, size of trade, and type of trading mechanism utilized.

As an example, EUR/USD futures TOB spreads in February during regular trading hours averaged between 0.61 and 0.67 of a pip, trading at the MPI of 0.5 for approximately 76% of regular trading hours year to date.

In the FX spot market, market participants will often establish a long or short position in FX spot and then maintain this position by ‘rolling it forward’ to a date in the future. This practice of rolling the position is done in order to extend the settlement date of the open position and to avoid physical delivery of the currency. This trading activity is usually for hedging purposes or to profit from changes in exchange rates, and thus, rarely has any immediate intention of taking physical delivery of the currency.

CME FX futures can be used to replicate this position and to create synthetic spot exposure whilst avoiding the costly process of rolling positions daily. Institutional participants usually focus their trading on the front quarterly CME FX futures contract since it is generally the most liquid expiry in the CLOB. Additionally, participants can also trade on a relationship/disclosed basis directly with preferred liquidity providers (LP’s) via both EFRP’S and block trades,⁵ both of which now benefit from a reduced MPI of 0.1 of a pip as of February 2021.⁶

A customer believing that the euro will depreciate steadily versus the US dollar between March and mid-June could express that view by selling 50 million EUR on March 17 in the OTC FX market and then roll its position daily until closing it out on Tuesday, June 15 to avoid physical delivery. In doing so, transaction costs and interest costs would be incurred daily.

Alternatively, the customer could replicate its FX spot position by selling 400 CME EUR/USD futures contracts with a June 2021 quarterly expiry date on March 17th. In order to calculate the number of futures contracts needed to replicate the position, take the notional size of the trade and divide by the notional size of the EUR/USD futures contract ‒ in this case it would be 50 million EUR divided by 125,000 EUR = 400 contracts. Assuming the customer only seeks to profit from changes in the EUR/USD spot exchange rate over its three-month investment horizon and thus has no intention of taking physical delivery, the fund can simply offset its short futures position by buying back its June 2021 futures contracts prior to futures expiration on the last trading day on June 15.

A customer needing to hedge its position in the belief that the euro will appreciate steadily versus the US dollar between March 2021 and mid-May 2021 could purchase a two-month IMM-dated OTC EUR/USD forward on March 16 with a notional size of 50 million EUR for delivery on Wednesday, May 19. Assuming the customer no need or intention of taking physical delivery of 50 million EUR, they can terminate this forward position by selling 50 million EUR on a spot basis on May 17 for delivery on May 19.

Alternatively, the customer could replicate this specific forward position by purchasing 400 CME EUR/USD futures contracts with a May 2021 monthly expiry date on March 16. To terminate its futures position, the bank can simply sell 400 May 2021 EUR/USD futures just prior to futures expiration on the last trading day on May 17.

• CME FX futures can be used as a complementary pool of liquidity to replicate OTC FX transactions in a cost and capital efficient manner.
• The pricing available in FX futures is not only firm with no last look but can often be different to pricing available in the OTC market. The spreads and liquidity available in FX futures can be seen and explored via tools such as the FX Market Profile tool.
• FX futures also enable the ability for customers to trade passively, to trade without an ISDA, and to mitigate counterparty credit risk.
• CME FX futures can be viewed and/or traded via a variety of front-end platforms including Bloomberg, Refinitiv, and TT.
• Regulatory changes such as the uncleared margin rules and the implementation of SA-CCR may act as further catalysts for change within the FX marketplace.

1. Based on CFTC data and disclosures
2. https://www.cmegroup.com/bright-future
3. https://www.cmegroup.com/education/articles-and-reports/cme-fx-futures-new-ticks-on-the-blocks.html
4. https://www.cmegroup.com/trading/fx/cme-fx-market-profile-tool.html
5. https://www.cmegroup.com/education/articles-and-reports/fx-futures-and-option-block-reference-guide.html
6. https://www.cmegroup.com/notices/ser/2021/01/SER-8711.pdf

For more details please contact fxteam@cmegroup.com