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What is a foreign exchange derivative?

Learn about the three types of foreign exchange derivatives.

Updated Feb 18, 2021

Fact checked

A term you’ll hear in forex is the foreign exchange derivative. While it sounds scary, it’s not nearly as complicated as you may think — it’s just a contract to buy or sell a currency at a specific time in the future.

There are three kinds of foreign exchange derivatives:

Forward contracts
Futures contracts
Options

Forward contracts

Forward contracts are typically used by investors who want to limit their risk to exchange rate volatility. For example, if you’ve sold goods to someone and agreed to get paid six months in the future, you might choose to enter a forward contract. You don’t want to lose your shirt if the exchange rate moves against you — you just want the money you’re owed.

Learn more about forward contracts.

Futures contracts

Futures contracts are typically used by speculators who are looking for large returns on their investments. These speculators try to make money based on the strengthening or weakening of a currency. Of course, the prospect of bigger profits is accompanied by greater risk.

Learn how futures contracts differ from forward contracts in a few important respects.

Options

An option gives you the option to buy or sell a currency at a certain price, and you can do so at any point up until the option expires.

If you have the right to buy a currency, you have a call option.
If you have the right to sell a currency, you have a put option.

In the world of options, you’ll often hear the terms long position and short position.

If you buy an option, you’re taking a long position. You’re hoping a currency will go up in value so you can buy it at a price that’s under its current value.
If you’re the one writing the option (for example, you’re selling it to someone), you’re taking the short position. You’re hoping a currency goes down in value so that the other party won’t exercise their option.

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Frequently asked questions

Check the mid-market rate between the two currencies you’re trading. The mid-market rate is what your money’s actually worth on the global market compared to another currency. It’s the midpoint between worldwide supply and demand for that currency — and the rate banks and transfer services use when they trade among themselves.
Use the mid-market rate as a baseline to compare against the rates provided by your bank or transfer service.

Thank you for your feedback!

Kevin Joey Chen

Kevin Joey Chen is a credit cards, banking and investments writer whose work and analysis have appeared on CNN, U.S. News & World Report, Business.com, Lifehacker and CreditCards.com. He's passionate about helping you get your finances in order by expertly navigating cutting-edge financial tools — including credit cards, apps and budgeting software.

What is a foreign exchange swap? What is a cross-currency basis swap?

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What is a foreign exchange derivative?

Learn about the three types of foreign exchange derivatives.

Articles

Forward contracts

Futures contracts

Options

Compare providers that can help you set up foreign exchange derivative

Compare up to 4 providers

Compare up to 4 providers

Frequently asked questions

Do money transfer services offer foreign exchange derivatives?

How do I know what a fair exchange rate is?

How can I ensure I’m getting the best exchange rate for my transfer?

Kevin Joey Chen

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