Rollover Interest and Margin Requirements.

Rollover Interest.  In the spot or over-the-counter foreign exchange market, foreign currency trades must be settled in two business days. For example, if a trader sells 100,000 Euros on Tuesday, the trader must deliver 100,000 Euros on Thursday.  However, much like the trading of futures contracts (and rolling over a contract to avoid delivery of the underlying commodity), a foreign currency position can be rolled over prior to the settlement date. As a service to traders, most online foreign currency dealers automatically roll over all open positions to the next settlement date at a predetermined time each day (e.g., 5 p.m. EST).  Rollover involves exchanging the position being held for a position expiring the following settlement date.

At the time of the rollover, funds are subtracted from (i.e., debited) or added  (i.e., credited) to accounts with open positions because of the automatic rollover. Funds are added to the account for positions in which the client is long (holding) the currency bearing the higher interest rate. Funds are deducted in the opposite circumstance. 

On Wednesdays, the amount added or subtracted to an account as a result of rolling over a position tends to be around three times the usual amount. This "3-Day" rollover accounts for settlement of trades through the weekend period.

In addition to factoring in interest, traders must be aware of any additional charges made by their dealer.  Some dealers will not pay the full amount of interest unless the trader has a sufficient margin level set for the account or will only credit partial interest.  In addition, some dealers charge the bid/ask spread on each rollover or a portion of the bid ask spread (that is, you would close out a long position at the lower bid price and purchase the new long position at the higher ask price).  Note in the futures area, a trader must pay the full bid/ask spread on each rollover.  However, given the fact that futures contracts can last several months or longer in duration and might be rolled over 3 or 4 times a year to keep a position open for 12 months, incurring the bid/ask charge and commissions is not terribly expensive.  Daily rollovers in the spot forex area are not comparable enough to justify charging the bid/ask spread.  .   

  

Rollover interest is the foundation of the so-called "carry trade" which exploits the differences between interest rates.  The carry trade will be discussed in a subsequent lesson, but the basic elements of it are as follows.  If the USD is yielding 4.25% and the JPY is yielding 0.00%, a trader who is long the USD will be credited with 4.25% on the long position (representing the net difference between the two rates).  On a $100,000 long position, this equates to $4,250 per year in rollover interest profit.  In order for a trader who is long the JPY in this pair for a 12 month period to break even, he or she will need the JPY to appreciate by 4.25% over this period to offset the rollover interest amounts which are debited from his or her account.  

Margin Requirements.  Most online foreign currency trading can be conducted on a highly leveraged basis. The requirements for margin leverage or gearing vary dealer to dealer.  However, margin ratios of 100:1 are not uncommon. 

What is margin?  Margin is a good faith deposit to ensure against trading losses. The margin requirement allows you to hold a position much larger than your actual account value. Most online foreign currency trading platforms perform  automatic pre-trade check for margin availability, and will only execute the trade if you have sufficient margin funds in your account.

In the event that funds in your account fall below margin requirements, you will generally be required to deposit additional funds or else dealer can close all of your open positions.

Let's look at an example involving a 1 lot purchase of the USD/JPY currency pair at 120.05.  The lot value is $100,000 and if the margin requirement was 2% or 50:1, you would have to deposit, or already have in your account, $2,000 to execute this trade.  In the event that the the price moved against you (in this case decreased representing a weakening of the U.S. dollar), you would have to deposit additional funds in the account to maintain 2% of the lot value.  For example, if the price changed to 119.50, you would suffer a loss of $460.25.  This is computed as follows:  Originally, you purchased USD 100,000 and sold 12,005,000 JPY.  To unwind or reverse this trade, you would need to sell USD 100,00 and purchase 12,005,000 JPY.  Due to the exchange rate change, the purchase of the JPY would cost $100,460.25 (12,005,000/120.50).  Hence, if you originally placed $2,000 into your trading account, your account value would have been reduced by $460.25 to represent the loss and you would need to put another $460.25 into the account in order to maintain the required margin level. 

 

 

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