In the trading of futures, “rollover” refers to the process of closing out open positions in soon-to- expire contracts in favour of contracts with later expiration dates. Rollover is unique to each product, and it produces a substantial impact upon volatility and price action within the marketplace. Confused about rollover? Not sure when to rollover to the front month contracts? Here is a concise list of official rollover dates for the most liquid instruments on the CME, ICE-US, EUREX and LIFFE.
Every futures trader should clearly understand what rollover is in futures trading as failure to ignore this rather simple feature of the futures markets can result in premature closing out on positions. While it wouldn't matter if your trades were running in profit, a trade closure on account of a rollover and one that is running at a loss can prove to be expensive.
In this article we take a look at what are the futures contracts rollovers and why they take place. Futures contracts, as you might know are derivatives which track the prices of the underlying market.
A futures contract is simply a hedging tool where a buyer and seller agree to buy or sell certain number of units in a commodity or an asset at a certain price for a future date of delivery. Most traders in the futures markets today typically use it to hedge against market exposure, so most of the trading is done for speculative purposes only rather than taking physical delivery of the asset.
Therefore, futures contracts need to be rolled over into the next contract month to avoid taking delivery or being obliged to deliver the underlying asset or commodity. The physically settled futures contracts are one of the two ways how futures contracts are settled upon expiry. Physically settled futures contracts are more prominent in non-financial markets or commodity markets in general.
These include, grains, livestock, precious metals etc. After the futures contract expires, it is generally the job of the clearinghouse to match the holder of the long contract and the holder of the short contract.
The trader holding the short contract is required to deliver the underlying asset to the holder of the long contract. To make the exchange, the holder of the long contract must place the entire value of the contract with the clearinghouse in order take delivery of the asset.
This can be a costly affair and can vary from one market to another. For example, one contract of crude oil controls barrels of oil. On top of this, there are additional costs of storage and delivery that the buyer must pay for. As you can see from the above, taking physical delivery of a commodity can be expensive unless you really know what you are doing. Cash settled futures contract, as the name suggests is settled for cash instead of physical delivery.
A futures contract is finite in its duration and therefore every futures contract comes with key specifications that traders need to be aware of. There is usually a few days gap between the last trading day and the expiration day, this is known as the roll date. It is during these days that volatile picks up and also you might start getting alerts from your futures broker to close out your open trades. Roll dates are unique to each contract and can vary in duration. Therefore futures traders need to bear in mind about this important variable.
While expiration date and last trading day are fixed, the roll dates can vary. It is essential to understand this major distinction as traders often confuse roll dates for expiration dates. The period of roll date is one of the most volatile periods as it marks the end of the current contract and the beginning of a new contract.
Therefore, volumes will start to shift significantly as traders start closing out the positions on the existing contracts and open new positions in the fresh or the front month contracts. Price volatility can be seen in both the contract periods. It goes without saying that traders who trade a contract during the roll dates will find it difficult to manage their traders and traders should also expect to see slippage in prices.
Trading volumes during these periods are typically split between the expiring contract and the new contracts leading to large price swings and gaps. The roll dates influence not just volumes but can also lead to higher spreads which makes it difficult to enter or exit from a day trading position. The volatility also increases the risk of slippage as day traders are likely to get bad fills which could eventually end up costing more than any profits you thought you could make.
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