Traders roll over futures contracts to switch from the front month contract that is close to expiration to another contract in a further-out month. Futures contracts have expiration dates as opposed to stocks that trade in perpetuity. They are rolled over to a different month to avoid the costs and obligations associated with settlement of the contracts. Futures contracts are most often settled by physical settlement or cash settlement.
Key Takeaways
- Traders will roll over futures contracts that are about to expire to a longer-dated contract in order to maintain the same position following expiry.
- The roll involves selling the front-month contract already held to buy a similar contract but with longer time to maturity.
- Depending whether the futures is cash vs. physical settlement may influence the roll strategy.
Why Roll?
Rolling futures contracts refers to extending the expiration or maturity of a position forward by closing the initial contract and opening a new longer-term contract for the sameunderlying assetat the then-current market price. A roll enables a trader to maintain the same riskposition beyond the initial expiration of the contract, since futures contracts have finite expiration dates. It is usually carried out shortly before expiration of the initial contract and requires that the gain or loss on the original contract be settled.
A futures position must be closed out either before theFirst Notice Day, in the case of physically delivered contracts, or before theLast Trading Day, in the case of cash-settled contracts. The contract is usually closed for cash, and the investor simultaneously enters into the same futures contract trade with a later expiry date.
For example, if a trader islonga crude oil futureat $75 with a June expiry, they would close this trade before it expires and then enter into a new crude oil contractat the current market rate and that expires at a later date.
Physical Settlement
Non-financial commodities such as grains, livestock and precious metals most often use physical settlement. Upon expiration of the futures contract, the clearinghouse matches the holder of a long contract against the holder of a short position. The short position delivers the underlying asset to the long position. The holder of the long position must place the entire value of the contract with the clearinghouse to take delivery of the asset.
This is quite costly. For example, one contract of corn with 5,000 bushels costs $25,000 at $5.00 a bushel. In addition, there are delivery and storage expenses. Thus, most traders want to avoid physical delivery and roll their positions prior to expiration to avoid it.
Cash Settlement
Many financial futures contracts, such as the popular E-mini contracts, are cash settled upon expiration. This means on the last day of trading, the value of the contract is marked to market and the trader’s account is debited or credited depending on whether there is a profit or loss. Large traders usually roll their positions prior to expiration to maintain the same exposure to the market. Some traders may attempt to profit from pricing anomalies during these rollover periods.
