Tom-Next
Tom-Next, short for 'Tomorrow-Next Day,' is a forex trading mechanism designed to allow traders to extend their currency positions beyond the traditional delivery date without actually taking physical possession of the currency. This process involves a simultaneous buy and sell operation over two business days to keep forex positions open overnight efficiently.
Purpose and Mechanism
The primary goal of Tom-Next is to facilitate traders in maintaining their forex positions overnight without the necessity of taking physical delivery of the currency. It is essentially an FX swap that either charges or credits a premium to the trader, depending on the currency interest rates involved. This swap replaces overnight positions with an equivalent new contract starting the next day, thus extending the position seamlessly.
Calculation and Cost of Carry
The tom-next rate, reflecting the cost of carrying a position overnight, is determined by adjusting the closing level of an open position based on the interest rate difference. If a trader holds a currency with a higher interest rate, they receive an interest payment; conversely, holding a currency with a lower interest rate necessitates an interest payment from the trader.
Alternative Example
Consider a scenario where a trader engages in the GBP/JPY by selling £200,000 and buying JPY at a rate of 150.50. To extend the trade beyond the spot date, the trader sells £200,000 tomorrow and repurchases it at the updated spot rate. With the initial GBP/JPY position at 150.55/150.60 and the new spot rate at 150.65/150.75, rolling the position would mean selling at 150.55 and buying back at 150.75, incurring a cost of 2.0 pips. For a £200,000 GBP/JPY trade at approximately £10 per pip, the market rollover cost would be 2.0 x £10 = £20 (excluding any nominal administrative fees), making the tom-next rate 1.0/2.0 in this context.