> What does the existence of the futures market allow me to do that I can't already do in this scenario?
Leverage.
So I had a look at live data for an example. As of writing, 1GBP = 1.28 USD. Let's look at some example scenarios, assuming I believe 1 GBP will be worth 1.41 USD (+10%) in 3 months and want to make as much money as I can with a $100k investment.
- I buy USD from a regular bank or currency exchanger and wait 3 months. If the price goes up 10%, I make $10k. If the price goes down 10%, I lose $10k. If nothing happens, I lose nothing.
- I buy GBPUSD futures contracts. I need $7346.25 margin to open the contracts and $5877 to maintain them (per https://www.interactivebrokers.com/en/index.php?f=marginnew&...) and I control 62500GBP ($80k) per contract. With $100k, I can buy 13 contracts and control $1.04M. If the price goes up 10%, I make $100k. If it goes down 10%, I lose $100k.
And then, for fun:
- I buy 86 options for a GBPUSD futures contract at a strike of $1.28 for $99k. If the price goes up 10%, I make $593k. If the price is at ~$1.30, I lose nothing. If the price is below $1.28, I lose $99k.
I'm no expert on futures however so there might be something wrong here, though the answer is definitely leverage.
You don't need a forward/future to introduce leverage.
We can trade GBP/USD between each other with as much leverage as we like without any future time conditions. All we need do is agree to pay each other the difference in value as the price changes, multiplied by our agreed leverage.
At some point, one or other of us can close the deal and settle the outstanding amount.
If you can't strike a deal directly, you go to an exchange or clearinghouse of some kind that will introduce buyers and sellers. Once again, leverage can be created without any forward or future.
You basically just recreated a forward where either party is able to unilaterally end the contract. (Forwards aren't standardized so can have weird quirks like this.)
Fair point. So where does the definition of a forward end? Could you then classify anything where you don't take delivery of the underlying entity as a 'forward', even if there is no end point and no promise of any kind of future time (however negotiable)? Where does the boundary lie?
A forward is just a future that isn't standardized and not traded on an exchange. Forwards are over the counter contracts that are written for each deal.
Forwards came first. You would go to an investment bank tell them you wanted to hedge whatever you had and they would write up the contract between you and them. Obviously there is no secondary market for these things and two contracts could have different terms in them.
So futures were invented. They standardized the underlying product (e.g. a type of wheat, a particular duration on bonds, a fineness of metal, etc), the expiration date, the delivery location (or financially settled), and the size. Now since all these contracts are fungible a market can be formed to trade them back and forth.
I understand the terminology difference of forwards and futures, what I was asking about was when does a deal become a forward? The standard "I'll agree to buy oil from you at this price next year" is obviously a forward, but a deal where there may be no particular timeline or even a promise of one seems to be more hazy.
The dividing line would be the requirement for all contracts to be equivalent and traded on a venue. So an expiration date is probably a requirement. I have a hard time imagining such an open ended contract.
Leverage.
So I had a look at live data for an example. As of writing, 1GBP = 1.28 USD. Let's look at some example scenarios, assuming I believe 1 GBP will be worth 1.41 USD (+10%) in 3 months and want to make as much money as I can with a $100k investment.
- I buy USD from a regular bank or currency exchanger and wait 3 months. If the price goes up 10%, I make $10k. If the price goes down 10%, I lose $10k. If nothing happens, I lose nothing.
- I buy GBPUSD futures contracts. I need $7346.25 margin to open the contracts and $5877 to maintain them (per https://www.interactivebrokers.com/en/index.php?f=marginnew&...) and I control 62500GBP ($80k) per contract. With $100k, I can buy 13 contracts and control $1.04M. If the price goes up 10%, I make $100k. If it goes down 10%, I lose $100k.
And then, for fun:
- I buy 86 options for a GBPUSD futures contract at a strike of $1.28 for $99k. If the price goes up 10%, I make $593k. If the price is at ~$1.30, I lose nothing. If the price is below $1.28, I lose $99k.
I'm no expert on futures however so there might be something wrong here, though the answer is definitely leverage.