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Spreads

If EUR/USD is quoted at 1.4250-525, the dealer is willing to purchase euros at US$1.4250 (bid price), and he is willing to sell euros at a slightly higher price of US$1.42525 (ask price). The difference between the bid price of US$1.4250 and the ask price of US$1.42525 is US$0.00025 and is called the spread. To the trader, the cost of entering and exiting a trade is reduced when the spread narrows. The exact cost of the spread on any trade is calculated thus –

Pip Value X Spread in Pips X Number of Currency Units in the Contract

For example, the cost of the spread on a EUR/USD trade of 1 standard lot of 100,000 units is –

US$0.0001 X 2.5 X 100,000

= US$25

Note: Pip Values differ for different currency pairs and are displayed in the column under [Pip Cost] on the Trading Station II when the screen view is set to [Simple Dealing Rates].

The spreads of all currency pairs traded on the MF Global FX Trading Station II platform are displayed as pips in the [Spread] column of the [Simple Dealing Rates] window.

The smaller the difference between the bid and ask prices, the less of a price spread that a trader has to overcome before he can make money on his position. This is why many dealers claim to have the lowest spreads. However, a trader should look beyond the advertised spreads.

Tight spreads will not lower the cost for a trader if trade execution always results in negative “slippage”. Negative slippage occurs when the trade is executed by the dealer at a price which is disadvantageous to the trader compared to the price requested. A trader who attempts to trade on a1-pip spread but frequently receives a 2-pip slippage actually faces a 3-pip spread.

Some dealers offer fixed spreads while others offer variable spreads. Generally speaking, fixed spreads are offered by a dealer who manages risks with a dealing desk while variable spreads are offered by a dealer who does not operate a dealing desk and offsets client positions directly with counterparties (liquidity providers).

Market regulation and trading technology have evolved in favour of “straight-through-processing” where trade execution, clearing and processing are automated without human intervention, and this has been a positive development.

MF Global FX offers No Dealing Desk Execution. Spreads on all currency pairs are variable and fluctuate according to market volatility. Spreads for major U.S. Dollar currency pairs fluctuate between 2 to 4 pips under normal market conditions.

Calculating PIP Values of Currency Pairs

The pip values for all currency pairs on the MF Global FX Trading Station II platform are conveniently displayed in the [Pip Cost] column inside the [Simple Dealing Rates] window. The following shows how they are calculated and some quick tips for verifying the displayed values.

In this analysis we shall use ABC and XYZ to denote any 2 generic foreign currencies on the Trading Station II platform.

ABC/USD

The pip value of a currency pair with the U.S. Dollar as the secondary (or quote) currency is a constant value and does not fluctuate with the exchange rate. It is always US$1 in a mini contract (10,000 units of the primary currency) and US$10 in a standard contract (100,000 units of the primary currency).

Examples include EUR/USD, GBP/USD, AUD/USD and NZD/USD.

USD/XYZ

The pip value of a currency pair with the U.S. Dollar as the primary (or base) currency fluctuates with the exchange rate. It can be calculated by this formula:

First, determine the decimal place for the smallest incremental change for the currency pair, ignoring fractional pip pricing. For USD/CHF, USD/CAD, USD/ZAR, USD/HKD, USD/SGD and USD/TRY, it is the 4^th decimal place. For USD/JPY, it is the 2^nd decimal place.

Then reciprocate (or invert) the quoted rate.

Pip Value = US$0.0001 (US$.01 for JPY crosses) X 10,000 (mini contract) or 100,000 (standard contract) X 1/ Quoted Rate

For example, if USD/CAD is quoted at 1.0710, the pip value of a mini USD/CAD contract is calculated thus:

US$0.0001 X 10,000 X 1/1.0710 = US$0.9337

ABC/XYZ

The pip value of a non-U.S. Dollar cross currency pair with ABC as the primary (or base) currency and XYZ as the secondary (or quote) currency is readily known in some cases. In other cases it requires calculation to verify the value.

Quick Tip: Where a quoted rate exists for USD/XYZ on the Trading Station II and its pip value is known, the pip value for ABC/XYZ shall be identical to that of USD/XYZ.

For example, based on the preceding example of USD/CAD quoted at 1.0710, the pip value of a mini contract of AUD/CAD is equal to the pip value of a mini contract of USD/CAD, which is US$0.9337.

Where no quoted rate exists for USD/XYZ on MF Global FX Trading Station II and its pip value is unknown, the pip value for ABC/XYZ can be calculated by this formula:

ABC0.0001 X 10,000 (mini contract) or 100,000 (standard contract) X 1/ Quoted Rate

For example, the pip value of a mini EUR/GBP contract is calculated thus (since there is no quoted rate for USD/GBP):

€0.0001 X 10,000 X 1/0.8530 = €1.17

To translate the pip value into US$, we will apply the EUR/USD exchange rate:

€1.17 X 1.4380 = US$1.69

Quick Tip: Where no quoted rate exists for USD/XYZ but one exists for XYZ/USD, the pip value of a non-U.S. Dollar cross currency pair such as ABC/XYZ on the Trading Station II is approximately equal to the big figure (or first 3 digits of the rate) of XYZ/USD.

For example, the pip value of a mini contract of EUR/GBP (ABC/XYZ) quoted at 0.8530 is approximately US$1.69, based on the concurrent quotes of the component currency pairs of EUR/USD at 1.4380 and GBP/USD at 1.6858.

What is Rollover?

Rollover is the interest paid or earned for holding a position overnight (after 5:00PM EST). Since each currency has an interest rate associated with it, trading a currency pair involves not only 2 different currencies, but their two different interest rates as well.

If the interest rate on the currency purchased is higher than the interest rate of the currency sold, rollover is earned or credited (positive roll). If the interest rate on the currency purchased is lower than the interest rate on the currency sold, then rollover is charged or debited (negative roll). Rollover represents an additional profit or cost to a trade.

Rollover Example

In Dec 2009, for example, the AU$ and US$ interest rates are:

AU$: 3.50%/4.00%

US$: 0.25%/0.75%

Please note that, like currency exchange rates, interest rates are also quoted with a bid/ask spread. A trader lends at the bid price and borrows at the ask price.

Let’s assume that a trader buys one 10K lot of AUD/USD @0.9000 and holds the position past 5:00PM EST. Using the examples of interest rates quoted above, a long AUD/USD position of 10,000 units carried past 5:00PM EST will receive a credit of 3.50% on AU$10,000, and a debit of 0.75% on US$9,000.

Or, the trader will receive a positive roll of (3.50% - 0.75% =) 2.75% on AU$10,000.

This translates to 2.75% X AU$10,000 = AU$275 per year. On a daily basis, the trader receives (AU$275/365=) AU$0.75. Converted to U.S. Dollars, (AU$0.75 X 0.9000=) US$0.68 is credited to his U.S. Dollar trading account.

This is an example of a “Carry Trade” where the trader takes a long position in a currency pair with positive rollover.

When is rollover booked?

5:00PM EST is considered the beginning and end of the forex trading day. Any positions that are open at 5:00PM sharp are considered to be held overnight, and are subject to rollover. A position opened at 5:01PM is not subject to rollover until the next day, while a position opened at 4:59PM is subject to rollover at 5:00PM.

A credit or debit for each position open at 5:00PM EST appears on your account, and is applied directly to your account balance.

Weekends and Holidays

Most banks are closed on Saturdays and Sundays, so there is no rollover on these days, but interest still applies for those two days. To account for that, the forex market books 3 days of rollover on Wednesday, making a typical Wednesday rollover triple the amount on Tuesday (assuming the rollover interest rates have not changed from Tuesday to Wednesday).

There is no rollover on holidays, but an extra day’s worth of rollover applies 2 business days before the holiday. Typically, holiday rollover happens if any of the currencies traded has a major holiday.

Where is rollover shown?

MF Global FX clearly displays rollover rates in the [Roll S] and [Roll B] columns on the FX Trading Station when the screen view is set to [Simple Dealing Rates]. The value displayed in [Roll S] applies to short positions while the value displayed in [Roll B] applies to long positions being rolled. Please note that interest rates are provided by multiple global banks and may change intraday during times of extreme market volatility.

Where is rollover shown?

Risk of the Carry Trade

The unwinding of many carry trades during the peak of the financial crisis led to spectacular losses in the forex market. However, in the second half of 2009 some carry trades have made a modest comeback, although traders seem to be more cautious with the use of leverage this time around. Nevertheless, as some economies remain sluggish while others exhibit signs of strong recovery, the interest differential between their currencies will persist and perhaps widen, thus reinvigorating the “carry trade” strategy.

Given the limited number of high-yielding currencies, what one cannot overlook is the risk of carry trade meltdown especially where the trade is crowded, as market setbacks albeit temporary can easily wipe out any positive roll earned. Although many traders believe that the positive roll will help cushion a potential drawdown, highly leveraged accounts may be exposed to margin call risk before the market can recover.

Trading Spreads

Trading spreads on the MF Global FX platform are very competitive with industry benchmarks. In normal market conditions, for example, spreads on currency pairs such as EUR/USD and USD/JPY can be as low as 2.0 pips.

Below are typical spreads of the more frequently traded currency pairs:

Currency Pair	As Low As	Typical Spreads*
EUR/USD	2.0	2.3
USD/JPY	2.0	2.3
GBP/USD	2.5	3.0
USD/CHF	2.5	3.0
EUR/CHF	3.0	3.5
AUD/USD	2.5	3.0
USD/CAD	2.5	3.5
NZD/USD	2.5	4.0
EUR/GBP	2.5	3.0
EUR/JPY	2.0	3.0
GBP/JPY	2.0	5.0
CHF/JPY	2.0	3.0
GBP/CHF	3.0	5.0
EUR/AUD	4.0	5.0
EUR/CAD	4.0	5.0
AUD/CAD	4.0	5.0
AUD/JPY	3.0	5.0
CAD/JPY	3.0	5.0
NZD/JPY	3.0	5.0

Why does MF Global FX not offer fixed spreads?

MF Global FX operates No Dealing Desk Execution which gives traders the ability to trade on rates provided by some of the largest banks in the world. These banks compete with each other to provide the best rate resulting in spreads as low as 2.0 pips. Instead of receiving fixed spreads from a market maker or dealing desk, the bid/ask spreads under the No Dealing Desk model may fluctuate depending on pricing provided by major global banks.

When might spreads widen?

Spreads are a function of currency volatility and liquidity conditions.

Spreads can widen in anticipation of release of economic data because banks and other liquidity providers may temporarily withdraw from the market and re-enter when risk has been fully re-priced in response to the new data.

Spreads can also widen during periods of low trading volume. For example, between the New York close and Tokyo open, trading in some currency pairs may experience above normal volatility due to the small number of liquidity providers, and this will lead to wider spreads which increase the entry and exit costs for traders.

Some currency pairs suffer from low liquidity and wide spreads particularly during certain times of the day. For example, USD/CAD during N.Z. and Australia hours, some European crosses during Tokyo hours, and most Emerging European crosses in late New York afternoon trading.

Trading spreads for the majority of currency pairs are most competitive during the hours when the major centers of London and New York are open between 5:00AM to 11:00AM EST.

* Typical Spreads in normal market conditions