Futures Rollover and Expiration Explained

A futures contract rollover is used by traders to switch from the current 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.

Reasons for Futures Rollover

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 which can be held 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.

Confirm Controlling Orders

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 buys ‘long’ 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.

Physical Settlements

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.

Cash Settlement

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.