Is Forex a financial derivative?
Depending on the exchange rate setting process, settlement mechanism, order size, trading costs, swaps and trading time, spot trading is not a derivative. Other types of currency trading such as binary options, futures, vanilla options and CFDs are all derivatives.
In finance, trading and trading a derivative is a usual instrument for investing through a contract.
Its value depends only on the value of an asset as the underlying asset.
Therefore, a change in its value occurs with the changes in the value of the underlying asset.
Among the different types of underlying assets commonly used with derivatives, include fixed income securities, stocks, currencies, credit events, and commodities.
Currencies are often traded on the futures exchange, spot contracts, binary options, (vanilla) options, and also contracts for difference (contracts for difference).
Regulated exchanges only offer (vanilla) options and currency futures.
On the other hand, binary options are provided by both OTC binary brokers and regulated exchanges.
It only offers CFDs and spot forex on an OTC basis.
Therefore, the complex structure causes a high degree of skepticism, especially for novice traders, about which instruments are derivatives.
The following aspects will help you identify people who are often categorized as derivatives.
The settlement process is completely different from the types of Forex trading.
For example, if the settlement is based on the exchange rate of a particular currency that is traded through a different market, the market considered may be a derivative.
When we mention spot Forex trading, the T + 2 settlement is usually followed.
This means that each transaction is settled within two business days from the date of execution.
However, there are some exceptions for pairs such as USD/TRY, USD/CAD, USD/KZT, USD/RUB, and USD/PKR, all of which settle at T+1.
From the short-term settlement period, it is clear that spot Forex is not a derivative.
Currency options usually have extended settlement cycles.
Moreover, the settlement of currency options contracts on all exchanges all depends on the exchange rate of commodities.
Therefore, the extended settlement cycle and the pricing mechanism make it clear that Forex options contracts are merely derivative products.
Contracts for Difference
Forex and CFD trading share a lot of similarities.
A trader can use a similar charting platform and get equivalent prices.
However for CFDs they are just contracts that allow the trader to bet only on the change in the price of the asset.
Unlike spot Forex trading, CFDs do not cause delivery, so the price of a particular currency in the CFD market tracks this within the cash market.
Therefore, as a result of the lack of delivery as well as price determination, CFDs are wholly derivative products.
Trades on the futures exchange are usually settled after 30 days with contracts of longer durations available hence the futures contract is a derivative.
Some of the binary options contracts offered by binary brokers expire within minutes, and none of them cause asset delivery.
The settlement is also done on the value traded in the spot Forex market.
Therefore binary options are considered derivatives.
Trading time, magnitude and order size
Derivatives markets place limits or use standard contracts on trading volume and order volume.
In the commodity exchange, currencies are traded 24 hours a day, 7 days a week, with no time restrictions.
Furthermore, brokers do not specify a standard order size.
Therefore, it shows restrictions on trading times, order size and lot size when spot forex trading is not derivative.
Currency futures can also be classified as derivatives due to restrictions such as specific trading hours as well as a maximum position size.
Currency futures are also considered derivatives due to similar restrictions.
For binary options, classifying them as derivative only by observing market restrictions on order size, trading time and volume is often difficult.
Likewise, watching the equivalent coefficient would not just classify CFDs as derivative contracts.
If the value of a particular instrument within the market depends on the value that is being traded in another market, then that market under study may be a derivative.
Forex spot trading is not derivative because the exchange rate of a particular currency is not derived from any particular data.
When observing the exchange rate calculation, currency futures contracts are classified as derivatives.
Options are generally derivatives where the premium is calculated only from the underlying price of the currency in the spot Forex market.
Also, with the support of the exchange rate setting mechanism, binary options are classified as derivatives.
An overnight fee is usually applied to holding a particular position in a particular pair to compensate each party for the loss of the physical delivery of cash.
When there is an exchange of assets there is no circulation, and therefore derivatives are traded.
When a trader opens an overnight position, a rollover fee is applied, which may be positive or negative depending on the spreads between the selected currencies.
Hence, spot Forex trading is not derivative trading.
Since there are no rollover or swap fees involved in trading currency futures, they are classified as derivatives.
Hence, there is no rollover fee in conventional currency options and therefore they are considered as derivatives.
Binary options do not incur swap fees as there is no real exchange of the assets involved and therefore, they are categorized as derivatives like CFDs.