Why won't this make easy money?

Discussion in 'Forex' started by granville, Oct 12, 2006.

  1. I think I found a way to some easy money. This can't be right, so please explain the error in my thinking:

    Go long the EUR/USD currency pair (currently at about 1.2531 on IdealPro).

    Then sell short 1 EUR FX futures contract (December contract at about 1.2574).

    This should yield about ~40 pips profit at expiration. This is the cost of carry.

    However, what is to stop me from going 10:1 leverage on both of these legs and making 10 times as much?

    Please tell me why I can't get rich by doing this?
  2. Did you take in to account rollover interest on your spot long, lets say you hold it for 60 days from now, you will pay aprox. $7/day=$420, there goes your 40 pips...sorry
  3. darmasdt


    This thread has brought me into thinking about using the swap free brokers. Some FX broker gives swap free facility for clients. :confused:
  4. In this case, I think the interest is credited to your account when you are long in the spot market.
  5. On spot pairs where the "numerator" pays a higher interest, the futures will trade lower and slowly rise to the spot rate as expiration approaches, to mimic the interest earned. When the "numerator" pays lower interest (as in EUR/USD), the futures trade at a premium and slowly fall to meet the spot rate as expiration approaches, to mimic the interest debited or "cost of carry" for holding that pair.

    The difference between spot and futures is (ideally) exactly what you are earning/paying out in interest, so no free lunch. Expectations on future changes in rate differentials is a whole other story.
  6. No, you get charged a debit of ~2.5% APR, unleveraged, for a long EUR/USD. That's the approx. difference in short-term rates, higher for USD than EUR.

    If the spot fx leg were interest-free, then, yes, you'd have risk-free arb.
  7. A simple yet confusing observation:

    In the stock market, when holding the underlying pays credits to your account (dividends), the futures trade at a premium.

    With currencies, when the underlying pays a credit (due to interest rate differentials), the futures trade at a discount.

  8. i think the fraction is confusing you. ie eurusd has a net debit to hold. so does jpyusd. (long eur, short usd, and long jpy short usd)

    accordingly, jpyusd spot is .008605 dollars/yen. JPYusd futures is .008633 dollars/yen.

    1 YEN / .008605 dollars = 116.21 yen/dollar (spot)

    and futures:

    1 YEN / .008633 dollars = 115.83 yen/dollar

    so cost to carry this trade to Dec expiration is .008633-.008605 = .00028 dollars/yen. yen cost more dollars in the future as opposed to now because they build in the cost of carry. Now you could make a great trade if you sold 1 year out JPY futures, and bought spot, then the Japanese central bank surprised everyone and raised rates to EQUAL US overnight rates. You'd make 4.5% of interest alone on that trade (since you sold futures that priced in cost of carry, and now the spot you own has no cost to carry).

    .000028 dollars/yen from 11/23 to 12/18 to carry the trade on 1 000 000 yen = $28 interest. (1 million yen = $8605 USD)

    and to find what negative interest different $28 represents:

    28/8605 = days borrowed/365 * (interest rate)


    28/8605 = 26/365*x
    .003254/.071233 = approx 4.5% annualized cost to carry this trade.

    So if you bought 1million yen spot at .008605, it would cost you $28 interest on top of that by Dec 18. In the meanwhile, the futures at .008633 have this figured in. So IF futures were priced EQUAL to spot, you could arb this and buy the futures, SELL the spot, and make $28 per 1million yen. (ie the carry trade, but with no position risk)
  9. In fact, here is a little spreadsheet I made right now which figures out what I just explained above. It tells you what the futures market is saying the cost of carry for the trade will be. If the numbers you plug in here turn out to be much different than what you can attain by going long spot and selling futures (or the opposite), then you have an arb opportunity.
    Will work in any market.
  10. Quiet1


    this is why you should ALWAYS use futures for non-day trades if your account warrants it. Your FX "broker" makes part of his money by charging you LIBOR+X% on your debit side and giving you LIBOR-X% on your credit side. Futures have flat LIBOR financing built-in (or near it anyways).

    #10     Nov 23, 2006