Greetings traders and welcome back.
Thank you for joining me as always. Chris here, bringing you
another Survival Guide. Today's discussion will be about the
Eurodollar futures, and I am not talking about the Forex pair
the euro dollar. Instead, this is something quite a lot different.
We're going to talk about where the Eurodollar came from,
as well as some of the trading strategies that traders are
incorporating the Eurodollar into their portfolio, and how they're doing it,
as well as some of the pros and cons to trading the Eurodollar
futures market. Before we dive any deeper, let's show
you how you can apply the Eurodollar futures to your chart
as well, using the Finamark platform.
That way you can take a look, or maybe apply some TA as we
are talking about these Eurodollar futures. In order to do
that, all we're going to do is go over to the ticker symbol on the top left,
we're going to give that a click, give ourself a "/GE", and
after that, we have the Eurodollar. Then we have all of
the different contract months.
I'll click August for this example, and I currently have it
set to a 4 hour chart, and we do have ourself all ready to go.
Now without further ado, let's get going.
Because of the immense popularity of the Forex markets, when
you hear "Eurodollar" it's completely understandable
if your head is first brought to the euro dollar exchange
rate market place. That is in fact, where most people's head
will go, but here, we are futures traders, and even if we're
Forex futures traders, what we're focusing on is the Eurodollar
future, which is not at all the exchange rate of the euro against the dollar.
Eurodollar futures contracts are time deposits that are stored
in banks outside the United States, so we can think about
it as money from the US that has been stored outside of the
US because at the end of the day, it is still denominated in US dollars.
Once again, Eurodollar futures contracts are time deposits
that are stored in banks outside of the US that are denominated in US dollars.
This means that they are outside of the Fed's jurisdiction,
which means they do bear higher-risk, thus they have a higher yield potential.
Now, why do we call it the Eurodollar?
Well, when they were first launched, the dollar-denominated
time deposits were held mainly in European banks. Due to this,
they became known as "Euro bank dollars", and initially,
well at least over the years, these instruments started spreading
within banks worldwide and today that name, "the Eurodollar", still
sticks around. Although not the most popular instrument that
is traded, Eurodollar futures are a very popular instrument
nonetheless, and are useful in investment mechanisms for both
advanced and beginner traders for various reasons.
The history of the Eurodollar is quite interesting, and it
dates back to the post-World War II era. This is because the
US came out as one of the global superpowers, and being
such a powerful country at the time,
there was such a high demand for the US dollar. Other factors
that went into why people were demanding US dollars had to
do with the economic aid that the US
was applying in Europe underneath the Marshall plan, as well
as just the booming US economy in general. The concept of
the Eurodollar started evolving during the 1950's and the
Cold War period. The Soviet Union began a process of moving
its dollar-denominated revenue from oil sales to banks outside
the US. The idea was to prevent the country from freezing
its assets as part of an aggressive geopolitical strategy. Over the years,
the Eurodollar has competed with the Certificates of Deposits,
which most people reference as CDs, for top place in the primary
short-term money market. In the late 1980's after a series
of events, including the Fed's limit on domestic deposits, the
commercial deficits in the US, and more, Eurodollars overtook
CDs. Since then, the Eurodollar has been the biggest and most
popular private short-term money market worldwide.
Today, the Eurodollar interest rates are used by investors
as a corporate funding benchmark.
They also use it as an indicator of credit risk levels on an interbank
scale, and it was in 1981 that the CME launched the first
cash-settled Eurodollar futures contracts.
The Eurodollar market isn't without potential problems.
The main problem that traders associate with the Eurodollar
market is the fact that it lacks detailed statistics
and official data regarding its growth.
The reason for that is simple. It's because it isn't run by any one government agency.
However from the available data, it does become clear that
it is the biggest financial market worldwide, with statistics
pointing somewhere around in 1997, that over 90% of all loans
were made this way, through the process of the Eurodollar.
If we dive a little deeper into the numbers,
we could point out that in 1969, the size of the Eurodollar
market was estimated at around 37 billion, but
in 1985, the market's net size was 1.67 trillion.
1.67, we missed the point, but 1.67 trillion
dollars. That's a large increase from 1969 at 37 billion.
Then in 2016, it was said to be almost around 14 trillion dollars.
The growth potential here is very, very real. Also in the
Nedbank "The Rise and Fall of the Eurodollar System" study,
the September 26th study concluded that the Eurodollar market is substantial.
They decided that it peaked at approximately .87
times the size of the total US banking system. The Eurodollar
futures market interests all types of investors worldwide,
from big corporations to governments from all around the
world. After the CME, the popular markets for trading Eurodollars
are London and Singapore individually.
The former is notably more popular because it operates during
both American and Asian trading sessions,
so that does make the Singapore get a slight edge over the London trade.
The textbook definition of Eurodollar futures states that
they are instruments that are cash-settled contracts, the
price of which is based on the three-month LIBOR at expiration
date. LIBOR, if you're unfamiliar, does stand for the "London Interbank Offered
Rate". In other words, the contract's price reflects, the LIBOR's
anticipated value at the time of settlement.
However, Eurodollar futures can really be summed up as being
aware that the ticker symbol is "GE" because that's how as
traders, we're going to find it, and it is the most traded interest
rate-based product in the world.
Once again, that is the most traded interest rate-based product
in the entire world. They are contracts on a three-month
$1 million Eurodollar deposit. More than 80% of the Eurodollar
futures trading itself takes place on the CME Globex here
in the United States where market participants are trying
to take advantage of real-time pricing and transparency.
Although Eurodollar futures are a preferred choice
for all types of market participants, including individuals,
governments, and institutions
like we already mentioned, they are of particular interest to companies and banks.
The reason is because Eurodollar futures allow them
to lock in the interest rate on funds
they plan to borrow in the near future at today's levels.
Let's take a moment to talk about how the Eurodollar futures contracts work.
It seems confusing to some at first, but it works in a relatively straightforward way.
The underlying asset is a Eurodollar time deposit with a
principal value of 1 million US dollars. Its maturity is fixed at three months.
Once the contract expires, the seller can transfer the cash
position rather than delivering the underlying asset. Eurodollar
futures contracts are traded through a price index. The value
of the index is calculated by subtracting the interest rate
of the futures contract from 100. This is it in a nutshell.
Once again, the value is calculated by subtracting the interest
rate of the futures contract from 100.
An example of this would be if the interest rate is set
at, say 3%, the index price is equal to $97
because 100 minus 3 equals 97. The Eurodollar futures contract's
price has an inverse relationship with interest rates. When
they go down, the contract's price rises, and vice versa.
To summarize, how the Eurodollar futures work,
we could say that they represent the three-month LIBOR for
a deposit with a value of 1 million dollars held in international
banks that is anticipated on the contract's settlement date.
The complete contract specifications for the Eurodollar futures
contracts can be found on the CME Group's website, or if you
don't want to navigate through that maze of information,
we will have it provided for you over on our blog post
so please make sure you check it out.
As far as the most important aspects of the contract,
the price quotation, we already discussed, is going to be the
contract of IMM index equals 100 minus R, where R equals the interest rate.
The ticker is going to be the "GE".
That's how we opened up the Eurodollar futures on the very
beginning portion of our video here today.
The trading hours will be Sunday through Friday, 5 p.m. to 4 p.m. Central time,
so nothing out of the ordinary there.
As far as the minimum price fluctuation, it is going
to be slightly confusing at first. The nearest expiring contract
month 1/4 of the interest rate basis point is going to be
.0025 price points, which is going to be $6.25
per contract, but all other months will be half of
an interest rate basis point, which means .005 price points
equals $12.50 per contract. Some of the most common trading
strategies revolving specifically around the Eurodollar futures
can be summed up as hedging, speculating, and portfolio diversification.
On the hedging aspect, financial institutions use the Eurodollar
future for hedging with fixed income derivatives.
That way, the banks can hedge against changes in the yield
curve for the near future that could otherwise negatively affect their returns.
Also on the other hand, companies use Eurodollar futures to
secure interest rates for funds they plan to borrow or lend in the future.
Then, we have speculating. Speculating is going to be the same
style of trading that most of us watching this video today
are currently employing. That means we are using technical
analysis or potential fundamental analysis to get an idea
of where we expect the value to go in the future, and as such,
we're looking to make trades based on our forecast and our
expectations, as well as our research done.
The Eurodollar can be traded just the same as say, the E-mini
S&P 500 in that regard. Then the third option is portfolio diversification.
Eurodollar futures contracts are preferred by institutional investors
and fund managers as part of a diversification strategy.
The instrument is a great way to spread risk across more
asset classes and balance the portfolio with something different
than typical tools, like precious metals and bonds for example.
The benefits of the Eurodollar futures as a tool for a portfolio
diversification are based on the fact that is a relatively
low correlation against common asset classes.
There are some very clear potential advantages to trading Eurodollar futures.
The first one is the fact that it is a very liquid instrument.
Over the years, the Eurodollar futures contract has established itself as
one of the top contracts on the CME, regularly surpassing
the E-mini S&P 500, or even crude oil futures, and this is
very attracting to all traders indeed.
Then we have the fact that it is in fact time tested. The
CME launched the Eurodollar futures contracts
first in 1981. The instrument became the first cash-settled
futures contract. It basically paved the way for other similar
futures contracts to follow, but also earned the trust of
investors having such a rich history and steady performance.
Finally, we have the versatility. To complement the concept
of the Eurodollar futures even further, the CME developed
additional variants of the contract, including bundles packs
and serial Eurodollars. The Eurodollar bundles allow traders
to buy and sell a series of futures in equal proportions,
starting from the front quarterly contract. The Eurodollar
packs allow the simultaneous trading of equally weighted
series of four futures contracts quoted on an average net
change basis from the prior day's close price. Then the
serial Eurodollars are very similar to the quarterly contract
futures, except they expire in different months.
The potential drawbacks that one might attribute to the Eurodollar
futures trading scene would start with the susceptibility
to political risk. Political factors, like trade wars and
impose tariffs, which are quite common nowadays, can hurt
international trade and affect businesses' imports and exports.
Since they often rely on Eurodollar futures to lock interest rates in advance,
the decreased economic activity can lead to a drop in the
demand for such instruments, thus lowering their price.
Then, we have the increased volatility around authorities'
meetings. Although the Eurodollar futures contracts don't
fall under a particular jurisdiction as an interest rate
product, they are still dependent on the policy of the Federal
Reserve. That is the main reason why around the dates of
crucial FOMC meetings, we can see large jumps in the Fed's
monetary policy, causing Eurodollar futures jumps. Finally,
we have they can be a bit complicated for beginners. When trading,
the basic rule of thumb is to be familiar with as much as
you can about the asset that you're trading. As a financial
futures contract, the Eurodollar requires the trader to take
into account normal and inverted yield curves, the concept
of linearity, convexity adjustments, and biases, and more.
This makes it appear way more complicated for beginners than
commodity futures, as an example.
To sum it all up, despite being complex for
beginners to jump into, it isn't as complex as it might seem
on the surface, and it is a very liquid marketplace. In terms of liquidity,
it regularly surpasses the E-mini S&P 500, as well as crude
oil. That is definitely a statement being made there.
It is also time tested. It has been around for quite some time, and its trajectory
in terms of its growth is, it's quite impressive.
There's not much else to say about it.
In the future, I hope you consider the idea of the Eurodollar
futures marketplace as a potential diversification
tool, or perhaps a new home for you to trade in. Until
next time, I wish you all the best of luck on your Gauntlet Mini
experience, but please do me a favor,
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I'll see you all very soon. Cheers folks!