Foreign Exchange Spot (FX Spot)
A foreign exchange spot transaction (FX Spot) is a contract between two counterparts, where currency is purchased right now for the spot price. In the contract, one party commits to purchase a specified amount of one currency for the other party, for a price that is specified in another currency. The exchange rate established in an FX spot is called the spot exchange rate.
An FX Spot contract will include information about when payment is to be made; this date is the spot date. The parties are free to set the date according to their own preferences, but most stick to convention since this makes trading easier. This means that you can expect (but always check the contract to be sure) a spot transaction contract that involves USD + EUR, CAD, TRY or RUB to have its spot date one bank day into the future from when the contract is created. This is usually written as T +1. For other currencies, T + 2 is more common, which means that the spot date is two bank days into the future from when the contract is created.
The FX spot is a very commonly traded financial instrument on the forex market. In the second quarter of 2013, the average daily FX spot turnover was approximately 2 trillion USD.
Examples of trading systems where FX spot contracts can be traded are Integral, Globalink, HotSpotFX, Currenex, Fxall, and eSpeed. Read more about FOREX trading systems.
Foreign Exchange Option (FX Option)
If you are the holder of an FX option, you have the right – but not the obligation – to exchange a certain amount of a certain currency for a certain amount of another prespecified currency, in accordance with the terms outlines in the FX option contract.
The FX option contract will include information about important factors such as which currency that you have the right to exchange and which currency you have the right to exchange it into, as well as the exchange rate that will be used.
The FX option contract will also specify when the exchange can take place. If it is a European-style FX option, the exchange can only be carried out on the expiry date of the option. If it is an American-style option, the exchange can be carried out on any day until the option has expired. There are also more novel FX options available, so it is important to know exactly what your trading with.
A few exchange do facilitate FX option trading, but a vast majority of all FX option trading takes place outside exchanges, so called over-the-counter trading (OTC). Examples of exchanges where you can trade FX options are The International Securities Exchange and The Chicago Mercantile Exchange.
Foreign Exchange Forward (FX Forward)
The Foreign Exchange Forward (FX Forward) is a contract between two parties, where they both become contractually bound to carry out a predetermined currency transaction at a certain date in the future. One of the parties is contractually bound to purchase a predetermined amount of a certain currency from the other party, and pay with a predetermined amount of another – also predetermined – currency. The other party is contractually bound to carry out this transaction as well; the Foreign Exchange Forward is not an options contract (i.e. the FX Forward is not a contract where only one of the parties has an obligation).
FX Forward contracts are often tailor-made to suite the needs of the two parties. For traders, the FX Future is a more convenient choice since the FX Future is standardized, making valuation etc easier. You can read more about FX Futures below.
Foreign Exchange Future (FX Future)
The Foreign Exchange Future (FX Future) is a standardized forward contract. It was created with traders in mind, and it is chiefly used for speculation and hedging. Examples of exchanges where you can trade in FX Futures are The InterContinental Exchange, The International Monetary Market and the Tokyo Financial Exchange.
The FX Future is a contract to exchange one currency for another at a predetermined date using a predetermined exchange rate.
The FX Future was created by the International Commercial Exchange in New York, USA in 1970. They used the USD as the base currency, and this practice is still widely adhered to in our time. It is possible to find FX Futures with another base currency than USD, but they are much more rare.
As a part of the aim for standardization, a vast majority of all FX Futures have an execution date that is one of these dates:
The third Wednesday in March
The third Wednesday in June
The third Wednesday in September
The third Wednesday in December
Foreign Exchange Swap (FX Swap)
A Foreign Exchange Swap (FX Swap) is a simultaneous purchase and sale of identical amounts of one currency for another with two different value dates. An FX Swap can be described as an FX Spot transaction right now + an FX Forward.
Example: The British company TTT chiefly uses GBP, but will receive a payment in CAD on March 31. While they could simply convert this into GBP right away (FX Spot), they are hesitant to do so because they know that they must pay a bill in CAD on September 1 and not having CAD on hand would expose them to currency risk. On the other hand, simply letting the CAD sit in an account is not appealing to TTT since they want to be able to use the capital right away.
The solution is an FX Swap. In accordance with the terms of the FX Swap contract, company TTT sell all their CAD as soon as they get access to them on March 31. This is the FX Spot part of the FX Swap. The FX Swap contract also stipulates that on August 31, company TTT has the right to purchase a certain amount of CAD for a predetermined price in GBP. TTT now knows that they will have CAD available to pay the bill on September 1, and they know exactly how much this will cost them in GBP. There is no longer any currency risk involved.
It is important to know that Foreign Exchange Swap and Currency Swap are not synonyms. A currency swap is a contract where to parties agree to swap principal a and interest payments on two loans taken out in different currencies.