What are interest rate derivatives and how do you trade them?

What are interest rate derivatives?

Interest rate derivatives are products (typically futures) used to trade on interest rate fluctuations. With us, you’ll use spread bets or CFDs to trade interest rate futures. With derivatives, you don’t own any assets outright and as a result, you can trade both rising and falling interest rates. Because interest rate derivatives are leveraged, you can open larger positions with a smaller upfront amount.

The outcome of your prediction will determine whether you make a profit or a loss. Just remember – leveraged trades are opened with a small deposit, called margin, to take a larger position.

With leveraged trades, it’s important to remember that there’s a high risk that your profits or losses will outweigh your initial margin amount, so always ensure you’re trading within your means and managing your risk.

Ways to trade interest rate derivatives

• Spread betting on interest rate futures
  Bet per point of the underlying interest rate’s price movements. Your profit or loss will be based on whether your prediction is correct. Spread betting on interest rates also attracts zero commission charges and taxes²

• CFD trading on interest rate futures
  Enter into a contract to agree to exchange the difference between your interest rate position’s opening price and its closing price – for profit or loss. This also attracts no commission charges

• Trading interest rate swaps
  Exchange interest rates or two different types of interest – usually in the form of futures – with a broker. Usually, the two parties involved are institutions rather than individuals, as many retail traders prefer the comparatively simpler process of trading interest rates with spread bets or CFDs. Note that we don’t offer interest rate swaps

How do interest rate derivatives work?

Interest rate derivatives mean that you’re agreeing to speculate on the future price of a specific interest rate, for example, the Pound base interest rate. Also, interest rate derivatives’ pricing is determined by underlying futures markets.

If you choose to spread bet on interest rate futures, you’ll bet on an amount of money per point of movement. So, if you’re speculating on the Short Sterling at £12.50 per point, for example, you stand to gain or lose £12.50 for every point that the Short Sterling moves, multiplied by your deal size.

When trading interest rate derivatives via CFDs, there are two different contract sizes: standard and mini. A mini contract is worth 20% of a main contract’s size. For example, one main contract of the Short Sterling is worth £12.50, while the mini is worth £2.50 per contract.

With CFDs, your profit or loss is determined by the difference between the Short Sterling’s price when you opened your position and when you closed it, multiplied by the contract value (main or mini) as well as by the amount of contracts you bought or sold.

Interest rate trading examples: spread bets and CFDs

Let’s say that you believe the Bank of England is about to raise interest rates, so you decide to open a position. We price interest rates at 100 minus the interest rate. So, if interest rates are currently at 4%, then the price will be 96 (which is 9600.00 on our platform).

You believe that the interest rate will be hiked in the UK, which will bring down the price of our underlying market – so you decide to open a short position using spread bets. You bet £10 per point of movement at the sell price of 9948.50. If the price falls to 9923.50 (25 points) and you close your position, you’d have made a profit of £250 (25 points x £10). If the price rose by 25 points instead (to 9973.50), you’d have lost £250.

But what if you decided to trade the interest rate changes using CFDs? You believe the Bank of England might lower the interest rate, which means a higher underlying price, so you go long on 10 CFDs when the buy price is 9949.50. Each contract is worth £12.50. If the interest rate does indeed fall and the underlying price reaches 9957.50, you’ll make a profit of £1000 ([9957.50 – 9949.50] x £12.50 x 10 contracts). If the interest rate rises instead and the underlying price falls to 9939.50, you’ll make a loss of £1250 ([9939.50 – 9949.50] x £12.50 x 10 contracts).

Remember, these are leveraged trades. As you can see, there’s a risk that your losses or profits can substantially outweigh your initial margin amount.

How to trade interest rate futures

Interest rate futures are used to speculate on interest rate changes that may be coming up in the next few months. You can trade interest rate futures in five steps:

1. Learn why people trade interest rates
2. Choose an interest rate market to trade
3. Open a trading account
4. Learn what moves interest rates
5. Place your trade

Learn why people trade interest rates

• You can go long or short depending on what the interest rate is doing
• Interest rate trading can be used to diversify your portfolio
• ​Interest rates are tied to the global economy. This can take some guesswork out of trading, as it’s often well-known when a new hawkish or dovish cycle will start
• Because interest rates are often inverse to other asset classes (for instance, when interest rates rise, stocks often underperform), they can be safe havens in times of volatility
• Interest rate derivatives are often used to hedge open positions, for instance hedging mortgages – by banks and institutional investors, but also by clued up individual traders

Choose an interest rate market to trade

You can speculate on some of the biggest and most influential interest rates in the world with us. Here’s what we offer:

Open a trading account

You can trade on interest rate futures using spread bets or CFDs – or both.

First, you’ll choose your account type. Then, you’ll create a live account. We require that you fill out a short form before we verify your identity. Lastly, you’ll fund your account to start trading.

Not ready to trade just yet? You can also open a demo account to practise your rates futures trading before starting with real money. Our demo account gives you access to a risk-free platform and £10,000 in virtual funds to hone your interest rates trading strategy.

Learn what moves rate prices

Interest rates are set at a national level by the central banks, often with a lot of discussion between countries. In the UK, for example, the Bank of England’s Monetary Policy Committee determines the bank rate.

This rate is determined by a host of factors. These include inflation levels (keeping the interest rate consistent with CPI), what state the economy is in (lowering interest rates in tough times hopes to encourage spending and saving) and conditions between banks, such as liquidity in interbank markets.

The interest rate set by the central bank (called the bank rate in the UK) will then inform the interest rates set by banks and other lenders to their clients.

Place your trade

How to trade interest rate futures

1. Log in to our web platform or mobile app
2. Go to 'Bonds and rates' or search for the rate you want to trade
3. Select 'buy' if you want to go long or 'sell' if you want to go short
4. Choose your position size
5. Set your stops and limits
6. Open your position

Techniques for trading interest rate futures

There are different ways to trade interest rate futures, but there are some common techniques that you can use to get you started.