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US Dollar Futures

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1. What is it?

US Dollar Futures are contracts where the underlying asset is the exchange rate of BRL for US dollars, for cash delivery.

Companies and investors cannot forecast what will be the exchange rate for a future date. Because of that, they are exposed to floats in the Exchange rate and, depending on their business, they can have their balances affected.

Dollar exchange rates depend on a number of factors, mostly changing with the capital influx. For instance, if a large amount of dollars is invested in Brazil, the local currency tends to gain value, meaning the BRL and the dollar will become closer to each other. If dollars leave the country instead, the BRL tends to drop, becoming more distant from dollars quotations. That currency flux depends mainly on foreign trade activities, foreign investments and capital moves (like an American investor buying local shares, for example), as well as exporting profits. Besides, the Central Bank usually make moves buying or selling dollars, in order to balance the local exchange rate.

That makes the dollar hedging an amazing decision making tool for companies and investors, once they can protect themselves from the currency changes. Exporting companies, for instance, use to have higher profits when the dollar is down, so they can use this strategy with dollar futures. Or, when a company has debts in dollars, a lower exchange rate leads to a larger debt in BRL.

This way, US Dollar Futures comprise a buying or selling move on dollars in a specific date in the future, for a predetermined pricing. However, by the expiration date one who executes a Dollar Future will not be receiving or delivering dollars. The contract sets the interests or losses to be paid in BRL.

The US Dollars Future is one of the most traded contracts at BM&F. It’s an asset with high liquidity and low volatility, so leaving positions is quite easy even before the expiration dates. Short selling is possible for this contract, meaning the investor doesn’t need to have a buying position in dólar futures to be trading contracts.


2. Characteristics

Terminology

Dollar futures terminology follows a pattern:

1. Trading code is “DOL”.

2. The letter corresponds to the expiry month, as follows:

Mês Letra
January F
February G
March H
April J
May K
June M
July N
August Q
September U
October V
November X
December Z

*International Standards

3. Expiry year

Example: for dealing with an US Dollar Future expiring by July 2014, we have the following code:

DOL N  14

Contract

DOL quotations are expressed in BRL per thousand dollars (US$ 1,000,00), with each contract providing an amount of US$ 50,000.00. The usual lot comprises 5 contracts and its liquidation in exclusively financial, by using the PTAX (daily exchange rate). DOL can be traded until the last work day of the expiring month, and maximum daily changes is set to 5% over the previous closure.

Day Trade

It is possible to close a day trade (buying and selling futures with same expiry date in a same day) of DOL futures.

Daily settlement

The daily settlement is nothing more than a mechanism used by BMF&Bovespa to balance the investor accounts. As futures change in a daily basis, generating credits or debts, investors are daily updated on their positions, earning or losing as prices change – in other words, they either get their profits or pay for their losses daily. The mechanism is a protection against any noncompliance among investors.

For DOL contracts, the daily adjustment happens the day after the deal, or D+1. However, on the expiry date only, updates are made in the same day, or D+0.

Guaranty Margin

It is a value deposited in cash or notes which will covering any noncompliance of an investor in daily settlements. Usually to operate options, the investor is forced to deposit a guarantee to mitigate risks. The margin is defined by the stock exchange, according to the analysis of the futures market. The assets accept as guarantee include cash, gold, government or private bonds, letters of pledge and quotes at funds.

In DOL futures, guaranty margins are fixed by contract, due to D+1, with a 20% discount for those investors who use it for hedging purposes. The margin can be anytime be reviewed by the stock exchange, though.

Usually, the guaranty margin corresponds to about 15% of the total opened contracts’ amount.

Operational Costs

There are two kinds of operational costs for dealing with cattle contracts:

Brokerage – it can change depending on the broker. However, most of them use the basic operational fees, stipulated by Bovespa. In this case, costs reach 0.2% for regular operations and 0.1% for the day trade, based on the theoretical redeem value.

Stock exchange fees – the stock exchange charges emoluments, and registration and other fees, set up by BM&F. Liquidation charges, for instance, cost about BRL0.60 per contract. Emoluments can change according to an average of contracts dealt during the last 21 trading sessions. Clearing fees usually reach about BRL0.01166 per contract, but can be lower depending on the trading volume. Also, ISS tax is charged over this particular operation.

Maturuty

Expiration dates for DOL futures can be set up for any month in the year. The expiration date as well as the last trading session happen by the last work day of the expiry month.

Liquidation

By the expiration date, all positions that remain opened, after a last adjustment, wil be financially executed by the stock exchange, by registering the inverse operation of the position held.

Mini Dollar Future

Operate with DOLs forces the investor to dispose large amounts of money, either for initial margins or the contract itself. The solution found for opening the market for smaller investor was creating a ‘mini’ contract.

Rules and features remain the same as the original contract’s, but mini dollar futures worth 10% of the standard contract’s – instead of US$ 50,000.00, their value reach US$ 5,000.00.

The advantage is the smaller capital investment needed, which leads to lower maintenance costs as well as diminished taxes.

Mini dollar futures terminology follows a pattern:

1. Trading code is “WDO”.

2. The letter corresponds to the expiry month, as follows:

Mês Letra
January F
February G
March H
April J
May K
June M
July N
August Q
September U
October V
November X
December Z

*International Standards

3. Expiry year.

Example: for dealing with mini dollar futures expiring by August 2014, we have the following code:

WDO Q 14

The default lot for mini dollar futures is 1 contract. Rules for initial margins, daily updates, liquidation, expiration and taxes are the same as the tradional contract’s.

Operational costs, however, are smaller. Brokers usually grant discounts for mini coffee, and even offer 50% discounts for day trades .There is also the rate of settlement and fees, however, Dollar mini contracts are exempted from registration fee and permanence.

Forward Points – FRP

Forwards for operating points have been authorized by BM&F by 2002. This strategy allows an investor to trading dollars today (PTAX) by using futures of dollars, as an alternative to trade with dollar futures properly.

The deal comprises an agreement made on a new pay day, for an amount to be increased or reduced from the daily exchange rate (PTAX). By the end of the trading day, FRPs (forwards points) are converted to points that make the dollar exchange rate to move up or down. Thus, it is possible to “lock” the today dollar (PTAX) through a position in this future dollar month.

Dollars ‘Roll Over’ – DR1

Roll over operations on Dollars – DR1 – comprise the strategy of dealing with two different expiration dates of dollar futures at the same time. It’s been authorized by BM&F as of 2008 for meeting the market demand.

Procedures and rules remain the same as regular contracts. However, for DR1 deals, instead of generating new positions in another contract, it will be automatically transformed in two different operations: the first will have the expiry date set up as being the DOL’s original date (short leg), and the second fixed for expiration in the DR1’s set up date (long leg). Thus, the DR1 not have open positions at the end of the day, being distributed on their business maturities Dollar futures contract.


3. Profitability and risks

Profits and risks from investing in dollars futures and forwards are necessariliy related to the country’s exchange rates and forecasts for that. For instance, if an investor buys a dollar future and exchange rates move down, he loses money, and the same happens to one who sell futures while exchange rates increase.

Dollar futures are widely used as hedging tools, for protecting investors agains exchange rate floats. Most common uses include hedging debts in dollars (against dollar increases) or revenues in dollars (agains dollar decreases). However, they can also be used for leveraging or speculating in the market.


4. Taxation

Taxes over US Dollar Futures follow the same logic of any other variable income investment. Income tax is equal to 15% of the sum of all daily adjustments (if positive) and is charged just when you close a position. Also, income withholding taxes of 0.005% are due over the full amount of gains.

For day trade operations, the income tax reaches 20% of profits, and the withholding tax other 1%.

All costs and fees paid for investing can be deducted from the income tax amount, including those from BMF&Bovespa. In case of losses, a compensation can be applied in any gains in the subsequential months, as long as the operations are similar.

The investor himself is responsible for paying all taxes, except when withholding taxes apply – then taxes must be accounted monthly and paid in every subsequential month. The calculation is carried out throughout the duration of the contract and not monthly.


5. Example

1. Dollar Futures

Let’s assume a company has debts in dollars totalling US$ 500,000.00 due to 3 months from now. It is afraid of dollars to move up, as if that happens, it must increase even more its payments to the creditor. Then, it decides on buying some dollar futures as a way of hedging the debts. Consider the following figures:

Debts on expiration US$ 500.000,00
Contract size US$ 50.000,00
Quotation US$ 1.000,00
Contracts purchased 10
Buying date 11/27/2012
Dollar prices 2,875
Maturity 02/01/2013

As each contract is US$ 50.000,00 worth, the company needs to buy 10 contracts to hedge the whole debts of US$ 500,000.00. Then, the company buys 10 contracts by 11/27/2012 for US$ 2.875 / US$ 1,000.00. So we have:

Date Adjusted prices Dollar prices Daily settlement
D+0 2.875,00 2,8750 0,00
D+1 2.900,00 2,9000 12,500,00
D+2 2.930,00 2,9300 15.000,00
D+3 2.915,00 2,9150 -7.500,00
D+4 2.910,00 2,9100 -2500,00
Total 17.500,00

D+0: in the first day, 10 contracts are purchased for US$ 2.8750/US$ 1,000.00

D+1: Dollar exchange already moves to US$ 2.9000. Thus, the daily change is found from the difference between the current and the previous quotations (US$ 2.9000 – US$ 2.8750) multiplicated by number and size of contracts (10 * US$ 50,000.00). So, as the dollar rises, we will have a adjustment of U.S. $ 12,500.00.

D+2: A positive adjustment of US$ 15,000.00. (US$ 2.9300 – US$ 2.9000) * (10 * US$ 50,000.00) = US$ 15,000.00.

D+3: A negative review, as dollar drops. (US$ 2.9150 – US$ 2.9300) * (10 * US$ 50,000.00) = US$ -7,500.00.

D+4: Another negative adjustment. (US$ 2.9100 – US$ 2.9150) * (10 * US$ 50,000.00) = US$ -2,500.00.

And so on until the expiring date. At maturity we will know if the company will make a profit or loss on the transaction Dollar future. If prices then reach US$ 2.9100, then we have:

1. Payment of the debts of US$ 500,000.00. It needs to purchase dollars by the expiration date, in this case the same as dollar futures’, or 02/01/2013.

2. If the dollar exchange rate were at US$ 2.875 (prices for 11/27/2012), the company would be paying only R$ 1,437,000.00 (US$ 500,000.00 * 2.8750). However, as the dollar hiked, debts also increased to R$ 1,455,000.00 (US$ 500,000.00 * 2.9100). So debts are R$ 17,500.00 higher.

3. Nonetheless, dollar futures generated profits to the company in the same value increased on debts, or R$ 17,500.00. This way, the company could offset losses from a higher exchange rate, reducing its exposure to dollar to zero, fixing its debt of U.S. $ 500,000.00 at a price of U.S. $ 2.8750..

2. Mini Dollar Futures

A student wants to make an interexchange to US. He sets up his cronogram and finds that the trip overall will be costing about US$ 50,000.00. While planning the travel in July 2012, the dollar is reaching BRL2.00. As his trip is scheduled only for January 2013, he is afraid the dollar to hike up till then, so he decides on buying some dollar futures, as follows:

Interchange total US$ 50.000,00
Contract size US$ 10.000,00
Quotation US$ 1.000,00
Contracts purchased 10
Purchase date July 2012
Dollar prices 2,00
Maturity January 2013

The student buys 5 mini dollar contracts, to hedge himself against a higher dollar price, so we have the following data:

Date Adjusted prices Dollar prices Daily settlement
D+0 2.000,00 2,0000 0,00
D+1 2.100,00 2,1000 5.000,00
D+2 2.080,00 2,0800 -1.000,00
D+3 2.150,00 2,1500 3.500,00
D+4 2.120,00 2,1200 -1.500,00
D+5 2.170,00 2,1700 2.500,00
D+6 2.160,00 2,1600 -500,00
D+7 2.200,00 2,2000 2.000,00
Total 10.000,00

If by Janaury 2013 the dollar reaches BRL2.20, the student’s trip will be about R$ 10,000.00 more expensive, making the interexchange almost impossible. However, as he purchased 5 mini dollar contracts, by the expiration date he is to earn the same R$ 10,000.00, making the trip viable.

*Taxes and transaction costs have been disconsidered.

**Daily settlement and expiration dates are always set up using the PTAX.


6. Advantages

  • The main advantage from investing in Dollar Futures is the possibility of hedging against changes in the exchange rate, which brings flexibility and a safe environment for individuals and companies looking for optimizing their cash flow.
  • Possibilities of speculating on dollar ups and downs, with a relatively low amount of money, and having profits and losses daily credited or deducted from an account.

7. Disadvantages

  • Daily changes;
  • Guarantee margins;
  • Income taxes;
  • Expiry dates. Thus, you cannot undefinedly hold positions on that, and everytime you want to keep them, you must postpone their expiry dates to a next exercise;
  • High risk investment.

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