Cost of Carry in FX Futures vs. Swap in Forex

[globalarbtrader]

Transaction cost in fx futures have never been cheaper than cash fx. At least not with reputable fx brokers that only pass through liquidity and charge commission without any markups or alteration of the price feeds.

Carry is built into fx futures so there is zero benefit in that regards of trading fx futures. My analysis has shown, and I trade around 400mln-1bln in usd notional per month in cash fx, that for me overall cost of execution are lower via cash than futures. But then again the cost comparison depends on a lot of different variables such as how specifically you execute in size should you trade larger volume.

In fact you may be exposed to additional risk trading the futures each time you trade the rolls.

In addition, only a few fx pairs are offered via futures whereas in cash you can trade close to 120 pairs.

With all due respect, this is mostly incorrect. Which FX broker do you work for?

The wider choice of pairs is true, but why confine yourself to a single asset class in futures? I'd rather trade 40 futures markets across different asset classes than 40 FX pairs that are mostly going to be pretty correlated.

Execution costs are pretty similar in futures and FX, except perhaps in massive size (non retail, if you have RFQ access to multiple banks.... maybe that is you....<shrugs>). The cost of rolling futures then is doing 4 trades a year - peanuts. And there is no risk if you do a spread trade (also usually cheaper). Futures also have much lower counter party risk. Even if you're an institution I'd rather be exposed to a clearing house than a gilt edged prime broker; and most retail customers are going to be exposed to some pretty dodgy broker credit.

"Carry is built into fx futures so there is zero benefit in that regards of trading fx futures"... is the biggest misleading comment. Probably the main benefit of futures over FX is the cost of carry.

Let's take USDGBP as an example. From the IB website the reference rate for USD Is 2.19% and for GBP is 0.801%. So you'd earn about 1.39% one way round and pay it the other way round on a futures trade (I say 'about' because the futures are priced off forward interest rates and a slightly different credit - but you'd still earn X and pay X).

However on a spot trade IB will only pay me 1.69% (above $10K) on USD and they charge me 1.801% to borrow GBP (if I borrow more than 80K). So instead of earning 1.39% carry I'm paying 0.11%: 1.5% difference. Doing the trade the other way round IB charge me 3.19% to borrow USD, and only pay me 0.301% in GBP interest. So instead of paying 1.39% carry I'm paying 2.89%, again 1.5% difference.

The 1.5% financing spreads for IB are actually quite competitive, most bucket shops charge 2, 2.5% or even more. Even institutional funds have to pay financing spreads - which is why if they have any sense they buy FX forwards rather than doing spot trades.

Because FX vol is quite low paying 1.5% a year in carry costs is an absolute killer. I'd agree with the other poster who said you shouldn't trade spot FX unless you're closing your positions every day (which I also think is insane but that's another story).

GAT

 

[GRULSTMRNN]

I get the sense that you somewhat misunderstood the question? The topic is not about diversification and hence the ability to diversify across different asset classes via futures is mostly a moot point in this discussion.

Regarding counterparty risk I strongly disagree with you. You are talking about settlement risk not credit risk. Your credit is with a broker not the exchange, hence you are not any less exposed to credit risk when trading futures. That has proven to be the case multiple times when brokers went under and supposedly segregated client funds went missing. In that case it made no difference whether the client intended to trade via futures or cash.

Your point about financing cost is very biased. You picked IB which charges insane markups on credits and debits. Your claim that they are competitive is absolutely incorrect. Furthermore, let's not compare IB with bucket shops. Let's keep bucket shops out of the picture. Most professional cash fx brokers pay/charge way more competitive rates such as Pepperstone FX, Baxter FX, LMAX, ... Trust me when I say I have done my research and analyzed transaction cost between both asset classes. Let's discuss further if you are informed about professional fx shops' financing rates, else it makes zero sense to talk without this vital information.

You can't even build a simple G10 fx basket via futures for lack of available instruments. Unless you wanna trade a very few select crosses you are out of luck with futures

Finally, you greatly underestimate roll risk. It's very easy to lose a dozen or more basis points when trading the rolls poorly, especially in size with wider spreads and in slightly less liquid pairs (and fx futures liquidity is amazingly thin beyond the top 3 pairs) . Additionally you give up a full spread each quarter, plus cost of execution, plus slippage. Multiply all that by 4 and you arrive at almost 100bps in additional cost

With all due respect, this is mostly incorrect. Which FX broker do you work for?

The wider choice of pairs is true, but why confine yourself to a single asset class in futures? I'd rather trade 40 futures markets across different asset classes than 40 FX pairs that are mostly going to be pretty correlated.

Execution costs are pretty similar in futures and FX, except perhaps in massive size (non retail, if you have RFQ access to multiple banks.... maybe that is you....<shrugs>). The cost of rolling futures then is doing 4 trades a year - peanuts. And there is no risk if you do a spread trade (also usually cheaper). Futures also have much lower counter party risk. Even if you're an institution I'd rather be exposed to a clearing house than a gilt edged prime broker; and most retail customers are going to be exposed to some pretty dodgy broker credit.

"Carry is built into fx futures so there is zero benefit in that regards of trading fx futures"... is the biggest misleading comment. Probably the main benefit of futures over FX is the cost of carry.

Let's take USDGBP as an example. From the IB website the reference rate for USD Is 2.19% and for GBP is 0.801%. So you'd earn about 1.39% one way round and pay it the other way round on a futures trade (I say 'about' because the futures are priced off forward interest rates and a slightly different credit - but you'd still earn X and pay X).

However on a spot trade IB will only pay me 1.69% (above $10K) on USD and they charge me 1.801% to borrow GBP (if I borrow more than 80K). So instead of earning 1.39% carry I'm paying 0.11%: 1.5% difference. Doing the trade the other way round IB charge me 3.19% to borrow USD, and only pay me 0.301% in GBP interest. So instead of paying 1.39% carry I'm paying 2.89%, again 1.5% difference.

The 1.5% financing spreads for IB are actually quite competitive, most bucket shops charge 2, 2.5% or even more. Even institutional funds have to pay financing spreads - which is why if they have any sense they buy FX forwards rather than doing spot trades.

Because FX vol is quite low paying 1.5% a year in carry costs is an absolute killer. I'd agree with the other poster who said you shouldn't trade spot FX unless you're closing your positions every day (which I also think is insane but that's another story).

GAT

 

[canoe]

Your point about financing cost is very biased. You picked IB which charges insane markups on credits and debits. Your claim that they are competitive is absolutely incorrect. Furthermore, let's not compare IB with bucket shops. Let's keep bucket shops out of the picture. Most professional cash fx brokers pay/charge way more competitive rates such as Pepperstone FX, Baxter FX, LMAX, ... Trust me when I say I have done my research and analyzed transaction cost between both asset classes. Let's discuss further if you are informed about professional fx shops' financing rates, else it makes zero sense to talk without this vital information.

Sorry to interject, but I find your mention of LMAX in your example pretty misleading.

Lmax standard commission is 0.0025% of the notional value trade, so the round trip will be 0.005%. 50 USD per round trip for one million dollars traded.

That is in no way, a competitive rate. In fact, it is expensive compared to other non-bucket shops.

 

[GRULSTMRNN]

We are talking about financing rates. And no, 50 per 1mln is not expensive for small volume traders. IB charges around usd 2.4 per 100k which works out to be around 50 bucks round trip for 1mln. The brokers I mentioned, including lmax, go a lot cheaper with large volume.

Sorry to interject, but I find your mention of LMAX in your example pretty misleading.

Lmax standard commission is 0.0025% of the notional value trade, so the round trip will be 0.005%. 50 USD per round trip for one million dollars traded.

That is in no way, a competitive rate. In fact, it is expensive compared to other non-bucket shops.

 

[canoe]

We are talking about financing rates. And no, 50 per 1mln is not expensive for small volume traders. IB charges around usd 2.4 per 100k which works out to be around 50 bucks round trip for 1mln. The brokers I mentioned, including lmax, go a lot cheaper with large volume.

Oh okay thanks for the clarification.

 

[CFerret]

Recent example on cost of carry. I checked Swiss franc future to short. March contract recalculated to USDCHF rate is approximately 100 pips below underlying now, which means you lose ~33 pips a month being short USDCHF via future. Holding spot USDCHF short costs about 30 pips a month, IOW, the same.

Did I miss something?

 

[sle]

Did I miss something?

Without looking at the actual rates, there are two possibilities
(a) term rates vs overnight (March is 3 month away)
(b) cross-currency basis (yup, it's a real thing)
My prior would be that there is no arbitrage in that market unless you are a retail broker raping your customers

 

[CFerret]

Without looking at the actual rates, there are two possibilities
(a) term rates vs overnight (March is 3 month away)
(b) cross-currency basis (yup, it's a real thing)
My prior would be that there is no arbitrage in that market unless you are a retail broker raping your customers

Agree. Significant carry cost difference would create obvious arb opportunities, hence is very unlikely to happen. No free money in markets beyond the typical risk-free return.

 

[globalarbtrader]

First an apology. As you probably realise 99% of the people talking about trading FX on the internet are dangerous idiots. Whenever I see a discussion about this subject I get a Pavlovian reaction, the red mist descends, and I assume that the person posting (a) has no clue what they are talking about and (b) has an agenda.

Anyway let me politely address your points.

First of all though I need to make a general point- most people on ET are retail investors, not professionals (and my distinction here is more about fund size and market access than knowledge or approach) . And nearly all retail traders trade spot FX with bucket shops.

What makes sense for a pro wouldn't make sense for someone who isn't a pro. I guess underlying my 'red mist' is due to the fact that many retail traders will read this thread and think that trading spot FX with a bucket shop is a good idea. In contrast in futures trading there is more of a level playing field; trades end up on the same exchange and the only advantage pros have is lower commissions, but the commission charged by the best retail level futures brokers is pretty competitive. If something makes sense for a professional futures trader it probably also makes sense for an amateur.

I get the sense that you somewhat misunderstood the question? The topic is not about diversification and hence the ability to diversify across different asset classes via futures is mostly a moot point in this discussion.

You can't even build a simple G10 fx basket via futures for lack of available instruments. Unless you wanna trade a very few select crosses you are out of luck with futures

Actually looking back at the thread I think you were the guy that first brought up diversification...

So I guess the point I'm making is that it's inconsistent to say that you can't get diversification *within* an asset class with a particular product, but then to ignore the fact that the same product allows you to diversify *across* asset classes. Diversification across asset classes is better, since the correlations are lower.

Of course you could trade both FX and futures to get access to other asset classes; and indeed that's what the fund I used to work for did, and for a well capitalised professional trader that isn't a problem. However for a retail investor (and most people on ET fall into this category) the best use of scarce capital to get maximum diversification is to trade *across* asset classes; if you can only trade say 5 markets because you don't have much capital, then it's better to trade 5 different asset classes than 5 different FX pairs.

(with limited capital spread bets or CFDs - if legal in your jurisdiction - would be a better way of getting that diversification than futures, but that's another story)

Finally, you greatly underestimate roll risk. It's very easy to lose a dozen or more basis points when trading the rolls poorly, especially in size with wider spreads and in slightly less liquid pairs (and fx futures liquidity is amazingly thin beyond the top 3 pairs) . Additionally you give up a full spread each quarter, plus cost of execution, plus slippage. Multiply all that by 4 and you arrive at almost 100bps in additional cost

Well personally I've never seen anywhere near that much in futures roll costs (maybe I don't trade them poorly enough ), so I guess we can politely agree to differ on that.

Regarding counterparty risk I strongly disagree with you. You are talking about settlement risk not credit risk. Your credit is with a broker not the exchange, hence you are not any less exposed to credit risk when trading futures. That has proven to be the case multiple times when brokers went under and supposedly segregated client funds went missing. In that case it made no difference whether the client intended to trade via futures or cash.

That's a fair point.

I'd argue that it's less likely that a futures broker will lose your money than an OTC broker, especially if the OTC broker is more at the bucket shop end of the spectrum.

But I'm not aware of any research about whether your are more likely to lose money with an FX broker than with a futures broker, so I accept that this is based on my intuition rather than hard evidence (anecdotally I can think of more FX brokers that have gone bust, but the smaller number of futures brokers were much larger so I don't know which way the pendulum swings on this).

Your point about financing cost is very biased. You picked IB which charges insane markups on credits and debits. Your claim that they are competitive is absolutely incorrect. Furthermore, let's not compare IB with bucket shops. Let's keep bucket shops out of the picture. Most professional cash fx brokers pay/charge way more competitive rates such as Pepperstone FX, Baxter FX, LMAX, ... Trust me when I say I have done my research and analyzed transaction cost between both asset classes. Let's discuss further if you are informed about professional fx shops' financing rates, else it makes zero sense to talk without this vital information.

As I said earlier most retail traders trade spot FX through retail brokers, and most of those through bucket shops. So I hope we can agree at least that for retail traders (which will include the majority of people who are likely to read this thread) the cost will be prohibitive.

Speaking from my own experience when I was working for a large fund we decided not to trade spot FX having done the transaction cost analysis because although the financing charges were lower than retail, they were still too high relative to the vol of the instrument. Instead we opted to trade FX forwards, since as a derivative you aren't actually financing anything, so there is no financing spread; the cost of carry implicit in the forward to cash spread is the same if you are long or short.

One good thing about IB (unlike many bucket shops it's fair to say) is that all their charges are transparent. So it's very easy for me to compare on a like for like basis the cost of trading futures vs FX. That's more difficult for the firms you mentioned. It's normally easy to find commission rates but funding rates are extremely difficult to find.

I did quickly google to see if I could find a charge sheet for any of these guys:

Pepperstone - rates only available to clients through MT4
LMAX no explicit information shown for FX, 2.5% or 1.5% spread on CFDs (from https://static-www.lmax.com/pdf/en/Trading-Manual.pdf)
Dukascopy (mentioned earlier in the thread) "It must be stressed that Dukascopy Bank adds its own carry costs to the rates applied to the clients" but no figures https://www.dukascopy.com/swiss/english/cfd/cfd-overnight-policy/
Baxter FX - no information available

So I do trust you when you say you have done your research, but unfortunately I have no way of verifying it for myself. To summarise then I think spot FX trading is a bad idea for retail investors, and in my personal opinion if I was to open a fund again I'd trade forward FX (as well as futures), in the absence of any further data to the contrary.

GAT

 

[GRULSTMRNN]

Apologies accepted.

Just a few points and feel free to address or to consider the case closed

• You still talked a lot about diversification across asset classes. This has never been the topic of this thread and i never brought it up or even hinted at it. Unless it is me who completely misunderstands, this thread is about the difference between cash and futures when trading fx, specifically the cost of carry. I mentioned the inability to build fx baskets via futures because I wanted to show a major drawback of fx futures, which is the very few instruments available. all carry considerations are useless when a trader can't express a view via fx futures for lack of available instrument.
• All my points pertain to retail investors. Every retail investor with a reasonable account balance can fund an account with the brokers I mentioned. Each broker I mentioned pays/charges reasonable funding rates. IB is definitely overcharging and dis-proportionally marking up funding rates to their advantage.
• Your point re credit risk between a broker that specializes in fx futures vs fx cash is misleading, this topic is not about fx bucket shops. I am not sure why you keep on coming back to this. Perhaps the following helps to calm the nerves: "I do not ever recommend anyone to engage in any capacity with an fx bucket shop"? Credit risk is determined through an analysis of management savy and ethics, balance sheet strength, and market perception.
• Finally here my claim, unless a broker or its liquidity provider marks up financing cost: By the argument of no arbitrage, futures fx cannot possibly provide a better carry than cash fx. Hence, I leave it to the reader to do his/her proper research and ask prospective brokers the right questions about their financing rate markups.

First an apology. As you probably realise 99% of the people talking about trading FX on the internet are dangerous idiots. Whenever I see a discussion about this subject I get a Pavlovian reaction, the red mist descends, and I assume that the person posting (a) has no clue what they are talking about and (b) has an agenda.

Anyway let me politely address your points.

First of all though I need to make a general point- most people on ET are retail investors, not professionals (and my distinction here is more about fund size and market access than knowledge or approach) . And nearly all retail traders trade spot FX with bucket shops.

What makes sense for a pro wouldn't make sense for someone who isn't a pro. I guess underlying my 'red mist' is due to the fact that many retail traders will read this thread and think that trading spot FX with a bucket shop is a good idea. In contrast in futures trading there is more of a level playing field; trades end up on the same exchange and the only advantage pros have is lower commissions, but the commission charged by the best retail level futures brokers is pretty competitive. If something makes sense for a professional futures trader it probably also makes sense for an amateur.





Actually looking back at the thread I think you were the guy that first brought up diversification...

So I guess the point I'm making is that it's inconsistent to say that you can't get diversification *within* an asset class with a particular product, but then to ignore the fact that the same product allows you to diversify *across* asset classes. Diversification across asset classes is better, since the correlations are lower.

Of course you could trade both FX and futures to get access to other asset classes; and indeed that's what the fund I used to work for did, and for a well capitalised professional trader that isn't a problem. However for a retail investor (and most people on ET fall into this category) the best use of scarce capital to get maximum diversification is to trade *across* asset classes; if you can only trade say 5 markets because you don't have much capital, then it's better to trade 5 different asset classes than 5 different FX pairs.

(with limited capital spread bets or CFDs - if legal in your jurisdiction - would be a better way of getting that diversification than futures, but that's another story)



Well personally I've never seen anywhere near that much in futures roll costs (maybe I don't trade them poorly enough ), so I guess we can politely agree to differ on that.



That's a fair point.

I'd argue that it's less likely that a futures broker will lose your money than an OTC broker, especially if the OTC broker is more at the bucket shop end of the spectrum.

But I'm not aware of any research about whether your are more likely to lose money with an FX broker than with a futures broker, so I accept that this is based on my intuition rather than hard evidence (anecdotally I can think of more FX brokers that have gone bust, but the smaller number of futures brokers were much larger so I don't know which way the pendulum swings on this).



As I said earlier most retail traders trade spot FX through retail brokers, and most of those through bucket shops. So I hope we can agree at least that for retail traders (which will include the majority of people who are likely to read this thread) the cost will be prohibitive.

Speaking from my own experience when I was working for a large fund we decided not to trade spot FX having done the transaction cost analysis because although the financing charges were lower than retail, they were still too high relative to the vol of the instrument. Instead we opted to trade FX forwards, since as a derivative you aren't actually financing anything, so there is no financing spread; the cost of carry implicit in the forward to cash spread is the same if you are long or short.

One good thing about IB (unlike many bucket shops it's fair to say) is that all their charges are transparent. So it's very easy for me to compare on a like for like basis the cost of trading futures vs FX. That's more difficult for the firms you mentioned. It's normally easy to find commission rates but funding rates are extremely difficult to find.

I did quickly google to see if I could find a charge sheet for any of these guys:

Pepperstone - rates only available to clients through MT4
LMAX no explicit information shown for FX, 2.5% or 1.5% spread on CFDs (from https://static-www.lmax.com/pdf/en/Trading-Manual.pdf)
Dukascopy (mentioned earlier in the thread) "It must be stressed that Dukascopy Bank adds its own carry costs to the rates applied to the clients" but no figures https://www.dukascopy.com/swiss/english/cfd/cfd-overnight-policy/
Baxter FX - no information available

So I do trust you when you say you have done your research, but unfortunately I have no way of verifying it for myself. To summarise then I think spot FX trading is a bad idea for retail investors, and in my personal opinion if I was to open a fund again I'd trade forward FX (as well as futures), in the absence of any further data to the contrary.

GAT