We have a good question here from Sergei asking what exactly is a stir futures contract. Now, thanks for the question.
So a stir futures contract is usually a short term interest rate futures contract, with short term meaning it will only include usually maturities of less than a year.
Now, think of these contracts as just another way for investors to trade short term interest rate expectations, or to try and hedge against any unexpected fluctuations in money market prices. So something that’s different from these contracts compared to something like bond yields, for example, are that there are not yield quoted, they’re normally price quoted.
So prices might look different compared to the yields of a particular interest rate. So, that’s important to know, because even though a falling yield usually refers to falling interest rates, the stirs are basically yield subtractors from a base of 100.
So, let’s do a quick example of that. So, let’s take out the calculator. So, let’s say the three month T-bill has a yield of 0.5%. The equivalent stir futures contract would have a value of a hundred minus that 0.5%. So your contract price for that particular stir would be 99.5.
So the price of these stirs move alongside bond prices, meaning they are inversely correlated to your yields as well. So, if you think interest rates are going to go lower, let’s say, between now and the next six months, six months from now, you can buy a stir futures contract of which there’s a couple available in the market. And if interest rates indeed move lower, your futures contract would be worth more, meaning that you made a profit.
o, let’s do a quick example. Imagine that you bought a stir. Let’s say you are buying a Euro dollar stir futures contract.
Now, keep in mind that the term Euro dollar, in terms of a stir or futures contract is not the same as the Euro dollar currency pair. In the sense of a stir, a Euro dollar just refers to dollar-based accounts or dollar denominated accounts that’s held in foreign banks outside the US.
So let’s say you bought a Euro dollar stir futures contract that’s based on the three month LIBOR or London Interbank Offered Rate. Now, that’s basically just the rate at which global banks lend to each other. Now, imagine that you bought the contract at, let’s say 99.50, like we just saw here. So you bought that Euro dollar futures stir contract at 99.50, and it’s based on the three month LIBOR. And imagine that the three month LIBOR at the time was 0.5%. So that’s where you paid 99.5.
Now, imagine that you bought it because you thought that interest rates were gonna go lower. Now, when the contract actually expires, imagine that the three month LIBOR is now at let’s say, 0.25%. That means that your Euro dollar futures stir contract has gone from 99.50 all the way to 99.75, which means that it’s worth more. And when it gets paid out, you obviously made a profit from it.
So these stir contracts are just short term interest contracts that tries to hedge against these unwanted or unexpected fluctuations in short term interest rates. And that is basically what’s referred to a stir futures contract.
So I hope that helps with the question, Sergei. Any other questions, don’t hesitate to let us know.