A futures contract rollover is used by traders to switch from the month which is closer to expiration into a different contract expiring in a later month. Unlike stocks, a futures contract has an expiration date. Futures are rolled over or transferred to a new month. This helps prevent the obligations and costs linked with the contract settlement. A futures contract is normally settled through physical or cash settlements.
When you roll a futures contract, you are essentially prolonging the maturity or expiration of your initial position and using the same underlying position in order to start a new contract for a longer term. This way, the trader can retain their initial risk position even if the initial contract has passed its expiration date (this is important because a futures contract can only have limited expiration dates). The roll is usually executed shortly prior to the expiry of the original contract and after loss or gain on the initial contract is settled.
If the contract is physically delivered, the position needs to be closed out prior to the first notice day. However, in the case of cash-settled contracts, the closure needs to happen before the final trading day. Normally, contracts are closed through cash, with the investor simultaneously entering the same contract having a further-out expiration date.
For example, if an investor ‘longs’ a $75 futures contract for crude oil having a July expiry, they would have to close the trade prior to expiration. They could then enter into a new contract for crude oil at the prevalent market rate and with a later expiration.
A non-financial commodity, such as metal, livestock, or grain usually makes use of physical settlements. Once the futures contract expires, the clearinghouse will match a long-contract holder against a short-contract holder. The long position will receive the asset from the short. The long-position holder will have to place the complete contract value with the said clearinghouse before they can receive the asset.
This can prove costly. For example, a single corn contract having 4,000 bushels will cost $16,000 at $4 per bushel – excluding the storage and delivery expenses. For this reason, a large proportion of investors prefer rollovers over physical deliveries.
A lot of futures contracts are settled with cash upon expiry. What this essentially means is that, on the final trading day, the contract value will be ‘marked to market’ and, depending upon whether the trader has made a loss or a gain, their account will be debited or credited. Large traders will usually execute a rollover before the expiration in order to keep their market exposure unchanged. A few traders even try to benefit from price anomalies that occur during the rollover phases.
There you have it, everything that you need to know about futures contracts, expirations, and rollovers. We hope that this guide will prove useful to you in your futures trading efforts.
CFTC RULE 4.41 HYPOTHETICAL OR SIMULATED PERFORMANCE RESULTS HAVE INHERENT LIMITATIONS. UNLIKE AN ACTUAL PERFORMANCE RECORD, SIMULATED RESULTS DO NOT REPRESENT ACTUAL TRADING. ALSO, SINCE THE TRADES HAVE NOT BEEN EXECUTED, THE RESULTS MAY HAVE UNDER-OR-OVER COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFIT OR LOSSES SIMILAR TO THOSE SHOWN.
Trading contains substantial risk and is not for every investor. An investor could potentially lose all or more than the initial investment. Risk capital is money that can be lost without jeopardizing one's financial security or life style. Only risk capital should be used for trading and only those with sufficient risk capital should consider trading. Past performance is not necessarily indicative of future results. All Software provided or purchased is strictly for educational purposes only. Any presentation (live or recorded) is for educational purposes only and the opinions expressed are those of the presenter only. Testimonials may not be representative of the experience of other clients or customers and is not a guarantee of future performance or success.
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