EuroDollars: the Biggest Market You’ve Never Heard of

What’s the most common futures market in nearly every managed futures portfolio we run across?  Corn? Nope… Crude Oil…not a chance. US 30yr Bonds… closer. It’s EuroDollars. You know, the official currency of the European Union time deposit denominated in US Dollars at banks outside the US.  A lot of people hear EuroDollar, and think Euro Currency, but as Peter Brandt so eloquently put it not long ago on his blog: “Eurodollars (not the currency, you idiot)”.

EuroDollars are in fact an interest rate product, not anything close to a currency product despite the ‘Dollar’ in the name. Yet the Aussie Dollar and Canadian Dollar futures are currency futures, not interest rate products – go figure. Now here’s where things get confusing, because while the term EuroDollar itself actually refers to the US dollars deposited abroad, EuroDollar futures contracts are derivatives on the interest rate paid on those deposits.

The CME explains the EuroDollar futures contract as this:

These contracts are quoted in terms of the “IMM index.  The IMM index is equal to 100 less the yield on the security.  ‘IMM Index = 100.00 – Yield.’

E.g., if the yield equals 0.750% —

the IMM index is quoted as 99.250.

‘IMM Index  = 100.000 − 0.750% = 99.250’

If the value of the futures contract should fluctuate by one basis point (0.01%), this equates to a $25.00 movement in the contract value.”

Still confused? Essentially, Eurodollars are cash settled futures contract whose price moves in response to the interest rate offered on US Dollar denominated deposits held in European banks.

The EuroDollar futures contract was launched in 1981, as the first cash-settled futures contract.  People reportedly camped out the night before the contract’s open like it was a new Star Wars movie, flooding the pit when the CME opened the doors. That trading pit was the largest pit ever, by the way, nearly the size of a football field and quickly became one of the most active on the trading floor, with over 1500 traders and clerks coming to work every day on what was then known as the CME’s upper trading floor.  That floor is no longer, with the CME having moved over to the CBOT’s trading floor and 98% of Eurodollar trading now done electronically.

CMEPhoto Courtesy: CME

So why do managed futures like EuroDollars so much?  The main reason is volume and liquidity, with EuroDollar futures the largest contract traded in the US at millions of contracts changing hands each day. Peter Brandt’s blog laid out the volume comparison nicely:

“The volume in Eurodollars (traded at the CME) is beyond anything you gold and crude oil groupies can comprehend. Consider the following volume figures for 2012:

Gold – 43.8 million contracts

Crude Oil – 134.2 million contracts

Eurodollars – 425.1 million contracts

Managed futures also like EuroDollars because their affordable.  Imagine a professional commodity trading adviser who wishes to risk only 0.50% of a managed account’s equity on each trade he places. Well, if he has a minimum of $200,000 – he is willing to risk $1,000 per trade. Now imagine he uses a market’s 100 day Average True Range as the measure for risk in that market. Well, any market that moves, on average, more than $1,000 in a day will be eliminated from that manager’s possible markets. Popular energy, metals, currency, and stock index markets immediately get left out (and that’s why individually managed account minimums are usually in the $500k to $1 million range).

The structure of the EuroDollar, however – where the price of the futures contract is 100 minus the interest rate, creates a scenario where the price moves very little on average, with each move equal to a basis point move in the interest rate. Short term interest rates simply don’t move that dramatically in short spurts. So, your average daily range in the September EuroDollars over the past 100 days has only been 1.4 points, or $36. Our same fictitious trader can now do 27 EuroDollar contracts with his $1,000 risk budget. (that also explains why there is so much volume in EuroDollar futures, as managers need to do 5 to 25 times as many EuroDollar futures as they do markets like Crude Oil or a stock index market to equalize volatility based risk across different positions).

So all hail EuroDollars, one of the most active, most heavily used futures contract your every day investor has never heard of.





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