Eurodollar Futures Contract Explained - YouTube

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,

and before you go, click that like and subscribe button down

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I'll see you all very soon. Cheers folks!