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Forex Rollover and Carry Explained

One of the complexities of trading foreign exchange is the whole rollover and carry interest aspect of things, as this recent question highlights.

Hi John,

My question is: What does carrying a trade past 5pm and thereby gain or pay interest, have to do with rolling over the T+2 forward currency contract? I understand that the banks would want to charge or pay interest at a given time, but why do some people call that carry trade and the interest associated with it rollover and why is the association so significant that on Wednesday 5pm when the rollover is for a contract that expires in 4 days because of the weekend they charge/credit an additional 2 days interest?

Also, what is the exact process of the rollover? If I’m long the EUR/USD and hold it past 5pm, do they liquidate that position and then enter another long for a new contract that expires in another 2 days? Wouldn’t that involve another cost in spread, closing and opening another trade? Or do they just reassign the T+2 to another contract?

Thank you very much for all of your help so far in clarifying a lot of my other questions. You seem to be the only one out there that has REAL answers.

Jon

I’ve never been in the “back office” where the actual transfers and whatnot take place, so I don’t know the specifics of that whole process, but I’ll offer up what I understand of things.

Let me tackle this by taking a look at what a spot forex trade is. It’s an agreement to exchange a set amount of one currency for another at a predetermined exchange rate in two business days (T+2). In speculative trading nobody actually wants to do the currency exchange, so at the end of each day, to avoid the exchange two days hence, they offset their open position, and then re-opening to start the new trading day. Some brokers actually do this in a very visual format which shows up in your trading log, while others make it a transparent thing.  If you trade with a market making broker you probably won’t see actual rollover as the broker is your counter-party.

Please note that there is no “liquidating” of positions because you don’t actually have anything to liquidate. This isn’t like stocks where you have shares and then sell them. In forex, like in futures, you have entered into a contract. What you do to “exit” a trade is to enter into a new contract with matching delivery specifications (quantity and date). That neutralizes you. If you were a bank, you may still have to actually exchange the currencies (depending on your counter-parties), but from the time you entered the offsetting contract you would no longer be exposed to any exchange rate movement risk.

As for the carry, I asked Jamie over at Forex Live to clarify things to make sure I got it straight (we used to work together and he was a bank trader once upon a time). Here’s the deal. When you do a trade it’s as if you are borrowing the short currency at its overnight rate, exchanging it for the long one, and depositing that at its overnight rate. So if you go long USD/JPY it’s as if you are borrowing yen at the JPY overnight lending rate, converting them to dollars, then depositing the dollars at the USD overnight deposit rate. The carry is the difference between what you pay on the loan and what you receive on the deposit. When you close out your trade you reverse the process. Some brokers handle carry separately, while some incorporate it into the position rollover. (Note that I said “as if”. These actual transactions don’t really take place.)

Now, if you’re wondering why you see the carry on the T to T+1 rollover if the exchange doesn’t take place until T+2, it’s because your P&L is credited immediately for the overnight carry you will pay/receive going from T+2 to T+3. That’s also why you don’t see carry the day you close a position (except for Oanda, which does continuous rather than daily carry).

By John

Author of The Essentials of Trading

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