Futures Trading 101

Let’s get this straight:  Interest rate futures have nothing to do with a borrowing rate at all.  When you buy an interest rate futures contract, it allows you as the buyer to lock-in a desirable future investment rate.  This keeps your debt obligation within control even as the values of interest rates change.  Such an underlying security on your debt is priceless.

How an interest rate futures contract works

Here’s how this type of futures contract works.  When the interest rate moves lower, the contract seller would pay the buyer for that lower interest rate at that given time.  When the interest rate goes higher, the contract buyer would pay the seller an amount which is more rewarding.  Instead of receiving whatever rate was specified in the futures contract, the seller would receive a better benefit.

A price index for interest rate futures

You need to be accurate in measuring the gain or loss in an interest rate futures contract.  That’s why a futures price index of this sort was devised in the first place.

If you are buying, subtract the futures interest from a baseline of 100 to compute the figure for your index.  When interest rates fluctuate, so do price indices.  You would observe that indices go higher as interest rates go lower, and vice-versa.

How to compute gains versus losses

The most common base price move would be a tick value of .01 which equates to 1 base point.  Other contracts may also have a tick of half a base point depending on the agreement.

Put simply, a tick upward would mean a gain in your contract.  A move downward would equate to a loss.

There is a way for traders to hedge their position in an interest rate futures contract.  You will have your fill of hedges, speculations, and pricings in Chapter 4.

In the U.S. market, interest rate futures are usually traded on the Chicago Mercantile Exchange or CME.  Some of the most common short-term interest rate futures you would encounter are as follows:

• Eurodollars. Three Month Eurodollars are actually U.S. dollars presently deposited in foreign commercial banks.  Banks are able to fund U.S. dollar loans when foreign purchasers need them without the effect of currency exchange rates.  It is currently the most highly-traded futures contract of all.

• Euroyens. Consider them very similar to Eurodollars.  They represent Japanese yen deposited outside Japan.

• One Month Libor. This also reminds you of a Eurodollar contract.  However, you’re talking about huge sums of money like a 3 million dollar deposit.

• One Month Fed Funds. Non interest-bearing, these deposits are lent out as funds to other Federal Reserve member banks but only on an overnight basis.

13 Week Treasury Bills. You get more security from risk-free investments such as quarterly T-Bills which are backed by the U.S. government.

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