Trading the Eurodollar Futures Contracts – Beginner’s Guide

Last Updated on September 8, 2023

When you hear Eurodollar futures, you might think it’s about the EUR/USD Forex currency pair. In reality, it has nothing to do with the FX market. The following guide will explore the topic of Eurodollar futures. Everything from what they are, through their history, contract specifications and symbol, to what to look for when navigating the Eurodollar market. We will also take a close look at the advantages and disadvantаges of the instrument to understand how the Eurodollar futures contract works in practice. So, let’s have at it!

Table of Contents:

• What is the Eurodollar
• History of the Asset
• The Eurodollar Market
• What are Eurodollar Futures
• How the Contract Works
• How to Trade It
• F.A.Qs

What is the Eurodollar?

There are very few people who hear the term “Eurodollar futures” and don’t immediately think it’s a futures contract that helps you take advantage of the EUR/USD. That’s a natural assumption to make. Forex is the biggest market in the world and said currency pair is the most actively traded one.

However, the truth is that they are something completely different. Eurodollar futures contracts are time deposits that are stored in banks outside the US, but denominated in US dollars. They are outside the FED’s jurisdiction. This means they bear higher risk, thus have higher yield.

Okay, but why is it called “Eurodollar”? When they were first launched, the dollar-denominated time deposits were held mainly in European banks. Due to this, they became known as Eurobank dollars, initially. Over the years, these instruments started spreading within banks worldwide. Today, they still retain their original name: Eurodollars.

Fun Fact: Currencies that are deposited in banks outside their home country are referred to as “eurocurrency”. For example, Australian dollars kept in a Swiss bank are considered eurocurrency.

Although not the most popular instrument, Eurodollar futures are a useful investment mechanism for both advanced and beginner futures traders. The reason being their unrivaled liquidity and long-term stability.

Eurodollar Futures Contract Explained

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The History of the Asset

Eurodollar’s history is an interesting one. It dates back to the post-WWII years. The US came out as one of the big winners and established itself as a global superpower. This led to a substantial increase in the demand for the US dollar. Other critical factors underlying the growing interest in the currency were the country’s booming economy and the economic aid for Europe under the Marshall plan.

The concept of the Eurodollar started evolving during the 1950s 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 a part of an aggressive geopolitical strategy.

Over the years, the Eurodollar has competed with Certificates of Deposit (CDs) for top place in the primary short-term money market. In the late 1980s, Eurodollars overtook CDs. The underlying reason was a series of events, including the FED’s limit on domestic deposits, the commercial deficits in the US, and more. Since then, the Eurodollar has been the biggest and most popular private short-term money market worldwide.

Today, Eurodollar’s interest rates are used by investors as a corporate funding benchmark. Often, they’ll also use it as an indicator of credit risk levels on an interbank scale.

Futures Contract Introduction

Now, let’s take a look at the history of Eurodollar futures contracts. They were launched in 1981 by the CME as the first cash-settled futures contract. The Eurodollar futures contract was initially traded within the CME’s largest pit. It was nearly the size of a football field and hosted over 1 500 traders.

Fun Fact: Prior to its launch, the Eurodollar futures instrument attracted so much interest that people were reportedly camping outside the exchange, waiting for it to open. Once the exchange opened, they flooded the CME’s upper trading floor.

Today, everything happens electronically. Anyone with an account at a futures trading brokerage can take advantage of the instrument with just a few clicks.

The Eurodollar Market

The main problem with the Eurodollar market is that it lacks detailed statistics and official data regarding its growth. The reason for that is because it isn’t run by a government agency.

However, from the available data, it becomes clear that it is the biggest financial market worldwide with statistics pointing out that in 1997, over 90% of all loans were made this way.

Let’s dive  a little deeper into the numbers. It’s worth pointing out that in 1969 the size of the Eurodollar market was at an estimate of $37 billion. In 1985, the market’s net size was $1.67 trillion. Later in 2016, it exceeded $13.8 trillion.

Also, in the Nedbank “The Rise and Fall of the Eurodollar System” study from September, 2016, the authors conclude that the Eurodollar market is substantial. It peaked at approximately 0.87 times the size of the total US banking system.

The Eurodollar futures market interests all types of investors from individuals, through big corporations, to governments from all across the world. After the CME, the popular markets for trading Eurodollars are London and Singapore. The former is notably popular because it operates during both the American and the Asian trading sessions.

What are Eurodollar Futures?

The textbook definition of Eurodollar futures states that these instruments are cash-settled contracts, the price of which is based on the three-month LIBOR at the expiration date. LIBOR stands for London Interbank Offered Rate. In other words, the contract’s price reflects the LIBOR’s anticipated value at the time of settlement.

However, if these explanations make it hard to get to the core of the concept, make sure to remember the following: Eurodollar futures are contracts on a three-month $1M Eurodollar deposit. You may ask why $1M, but will get back to this question when we focus on the way Eurodollar futures work. Now let’s get a closer look at the instrument.

The Eurodollar futures (symbol “GE“) is the most traded interest rate-based product in the world. More than 80% of the Eurodollar futures trading takes place on the CME Globex. Market participants 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, they are of particular interest to companies and banks. The reason is because Eurodollar futures allow them to lock the interest rate on funds they plan to borrow in the near future, at today’s levels.

That way, companies can take advantage of a more convenient way to invest excess cash, settle international transactions, provide short-term loans, or finance their exports and imports.

On the other hand, banks use these instruments to hedge against FOREX risk when trading fixed-income derivatives. The fact that the US dollar is a liquid currency provides them with the chance to fund dollar-denominated loans to foreign clients, without bearing any exchange risks.

Analysts forecast that they expect the Eurodollar futures market to continue to grow as long as the dollar remains the dominant currency worldwide.

How the Contract Works

Although the concept of the Eurodollar futures may seem kind of complicated, the truth is it works in a very straightforward and easy-to-understand way.

The underlying asset is a Eurodollar time deposit with a principal value of one 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. For example, if the interest rate is set at 3%, the index price is equal to $97 (100 – 3 = 97). This means you can determine the interest rate simply by looking at the value at which the futures contract is quoted. If it is quoted at $95.25, then the interest rate is 4.75%.

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.

So far, so good. But let’s take a detailed look at the interest rates. First of all, we should specify that Eurodollar futures are LIBOR-based derivative instruments. Why LIBOR-based? Because LIBOR is considered the primary benchmark for short-term interest rates, at which banks borrow from the interbank market.

So, to summarize how Eurodollar futures work, we should say that they represent the three-month LIBOR for a deposit with a value of $1 million, held in international banks, that is anticipated on the contract’s settlement date.  

Eurodollar Futures Contracts Specs

Let’s now take a look at the official contract specs for the Eurodollar futures contract (“GE”), issued by the CME:

Contract Unit	$2 500 x Contract IMM Index
Price Quotation	Contract IMM Index = 100 minus RR = three-month London interbank offered rate for spot settlement on 3rd Wednesday of contract month.
Trading Hours	From Sunday to Friday from 5:00 p.m. to 4:00 p.m. CT
Minimum Price Fluctuation	Nearest expiring contract month:One quarter of one interest rate basis point = 0.0025 price points or $6.25 per contract. All other contract months:One half of one interest rate basis point = 0.005 price points or $12.50 per contract. The “new” nearest contract begins trading in 0.0025 increments on the same trade date as the last trading day in the expiring “old” nearest contract.
Product Code	GE
Listed Contracts	Nearest 40 months (i.e., 10 years) in the March Quarterly cycle (Mar, Jun, Sep, Dec) plus the nearest 4 “serial” months not in the March Quarterly cycle. The new March Quarterly contract month for delivery 10 years hence is listed on the expiration day of the nearby quarterly contract month.
Settlement Method	Financially settled
Termination of Trading	Second London bank business day before 3rd Wednesday of the contract month. Trading in expiring contracts terminates at 11:00 a.m. London time on the last trading day.

How to Trade It

The answer to this question depends on the purpose of the trader. Whether it is to hedge, speculate, or else. Before taking a look at how that decision affects your Eurodollar futures trading strategy, let’s say a few things about the mechanics and the basic principles to follow when buying and selling the contract.

First of all, it’s essential to identify what the changes in the futures contract’s price can tell us about the LIBOR. For example, if the trader buys a single Eurodollar futures contract for $95.00, and it goes up to $95.05, that means a LIBOR change from 5.00% to 4.95%.

Okay, but what does this mean in terms of profit? Sincene basis point equals $25 per contract, in this case, the trader makes $125 (5 basis points x $25 per contract).

Now, let’s continue with the ways to trade the Eurodollar futures.

Hedging

Banks and companies both use the instrument to hedge against interest rates risk.

Financial institutions, for example, use Eurodollar futures for hedging  with fixed-income derivatives. That way, banks can hedge against changes in the yield curve for the near future that could otherwise negatively affect their returns.

On the other hand, companies use Eurodollar futures to secure interest rates for funds they plan to borrow or lend in the future. Here is how this works in practice.

Imagine that company ABC plans to expand its production line over the Summer months when its business slows down a bit. Their forecast reveals that the project requires $5 million available at the beginning of April. Considering that a single Eurodollar futures contract is a three-month time deposit worth $1 million, the company can lock in the interest rates at their current level by short-selling five April Eurodollar futures contracts.

Because the price reflects the interest rate at the time of settlement (April, in this case), the company profits from a potential interest rate increase. This may in turn lower the price of the April Eurodollar futures.

Let’s put that in numbers. For example if on January 1^st (three months before April 1^st), the April Eurodollar futures contract was priced at $95.00 (interest rate of 5%). The final closing price is set at $94.00. That indicates a 1% projected increase in the interest rates. Selling five contracts at $95.00 in January captures a profit of $2 500 per contract. It’s 100 basis points x $25 or $12 500 for the whole trade after covering the short position.

What the company does here is to offset the expected rise in interest rates. It locks in the LIBOR three months in advance by making a short sale in January.

Speculating

Traders who specialize in trend-following strategies, enjoy the Eurodollar futures because the asset often records long-term trending price movements, usually lasting over a year or more.

On the chart below, you can see two clear trends (one bullish and one bearish), taking place in the span of almost seven years. The first one lasted for 15 consecutive months, while the bears trended for more than 27 months.

Around such events, the asset tends to get more volatile. That means scalpers and the more-aggressive traders become slightly more active.

Non-directional traders, on the other hand, prefer the instrument for allowing them to place bids and offers at the same time. That’s how they try to capitalize on the bid-ask spread.

Large-scale investment firms, involved in market-making activities, use the Eurodollar futures due to their deep liquidity and relatively low intraday volatility.

The Eurodollar futures market is also a suitable environment for traders, specializing in applying advanced methodologies like arbitrage trading. What they do is first inspect the market for price discrepancies. Then they buy the contract from a market where it trades at lower prices. Finally, they sell it where the price is higher.

Portfolio Diversification

Eurodollar futures contracts are also attractive to institutional investors and fund managers. At least by the ones seeking an efficient, yet unconventional tool for portfolio diversification. The instrument is a great way to spread the risk across more asset classes. It can help you balance your portfolio with with something different than typical tools like precious metals, bonds, etc.

The benefits of the Eurodollar futures as a tool for portfolio diversification are based on the fact that it has a relatively low correlation against the common asset classes.

For further information regarding Eurodollar futures trading strategies and ideas, you can refer to the CME’s guide.

Advantages and Disadvantages of Trading Eurodollar Futures

Like any other investment opportunity, Eurodollar futures contracts come with their own share of drawbacks. They have their flaws, but also their benefits. What makes these instruments attractive to some traders, makes others find them less appealing. Let’s take a closer look at their pros and cons:

PROS

Very liquid instrument

Over the years, the Eurodollar futures contract has established itself as one of the top contracts on the CME. It regularly surpasses the E-mini S&P 500 or Crude Oil Futures. This has attracted investors seeking instruments with high daily trading volume and open interest (number of open contracts).

Time tested

The CME launched the Eurodollar futures contract 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 a rich history of steady performance.

Versatility

To complement the concept of Eurodollar futures, the CME developed additional variants of the contract. This includes Bundles, Packs, and Serial Eurodollars.

The Eurodollar Bundles allow traders to buy/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.

The Serial Eurodollars are very similar to the quarterly futures contracts, except that they expire in different months.

CONS

Susceptible to political risk

Political factors like trade wars and imposed tariffs can hurt international trade and affect businesses’ imports and exports. Unfortunately these are all too common nowadays. 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. 

Increased volatility around authorities’ meetings

Eurodollar futures contracts don’t fall under a particular jurisdiction. That said, as an interest rate product, they are dependent on the policy of the Federal Reserve. For that reason, the volatility in the Eurodollar futures’ price jumps around the dates of crucial Federal Open Market Committee gatherings. The result of these gatherings can influence the FED’s monetary policy.

To better navigate this, you can use the CME’s FedWatch tool.

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. 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, for example.

F.A.Qs