Rollovers and Expirations in Futures Contracts

A futures contract legally obligates an investor to buy or sell a specific security or commodity at a predetermined price and time, and it’s facilitated on the futures exchange. 

When the future contract expires, the buyer needs to buy the agreed asset at the predetermined price, regardless of the market price on the expiration date. The seller is obligated to deliver the asset.

Because futures contracts are standardized, they specify the quantity, quality, location and physical delivery time of the asset. The contract applies the same terms to both parties.

A futures contract provides the buyer with certainty for payment of an asset at a specific price and its delivery on a specific date. The seller receives assurance that the asset will be sold on the agreed-upon date.

Investors use futures contracts to hedge the price of an asset, with buyers hoping to pay less for it on the expiration date than the market price and sellers wanting to sell it for a higher price than the spot price on the day of delivery.

Futures contracts enable buyers and sellers to speculate on the price of an asset, hoping to make a profit.

Explanation of the Concept of Rollovers in Futures Contracts

A rollover in a futures contract enables the investor to extend the expiration of an initial contract by closing the future position near the expiry date and opening the same new position with a later expiration date.

The profit or loss of the initial contract needs to be settled before the last trading day by cash. With a physical-delivery contract, the investor needs to close it before the first notice day. Once the position is closed, the investor automatically enters the same futures contract with an extended expiry date.

The current position is offset by a new position. As an example, if you have a long position, you would sell the current position before the contract expires and then buy the same position for the next month simultaneously.  

An investor will use a futures contract rollover when the current trend is expected to continue from one month to the next. The investor wants to optimize profits by taking advantage of the trend by closing out the position at a future date.

Investors need to pay rollover costs, and the new contract could cost more than the previous one, resulting in paying a premium to extend the contract. 

By rolling over a futures contract, the investor reduces the possibility of incurring a loss for their hedged position.

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Reasons Why Traders Choose to Roll Over Their Futures Contracts

Investors use rollovers as a risk management tool. A futures contract enables an investor to lock in a specific price for an asset on a future date to avoid extreme price fluctuations, potentially preventing the possibility of paying higher prices than current market prices.

A rollover helps investors to reduce potential losses. It can also help investors obtain optimal profits if a favorable trend persists for several months.

Rollovers also act as a strategy to diversify your portfolio. You can turn a short-term trade into a longer-term position to achieve a favorable result.

Explanation of the Expiration Process in Futures Contracts

The expiration date is the last day that the contract can be traded. Once the contract expires, it cannot be traded any longer. The settlement process starts when the expiration date is reached.

Futures contracts for U.S. stocks and indexes expire on the third Friday of every third month. For 2023, the expiration dates are March 17, June 16, Sept. 15 and Dec. 15.

The exchange that provides the market fixes the expiration dates of each futures contract. 

Discussion of the Factors That Influence the Expiration of Futures Contracts

The main factors that influence the expiration of futures contracts are the impact on the asset’s trading volume, price reversal after expiration and extremely high volatility of the returns on the expiration day.

Supply and demand are used in a futures contract to determine if it’s fairly valued, as well as if the price will increase or decrease. The futures markets are interrelated, and supply and demand can be connected, as some futures contracts serve as an input for other contracts.

As an example, oil prices make up the majority of the gasoline price. These two commodities are connected, so an investor focusing on the supply and demand of gasoline while disregarding crude oil might overlook the importance of these related markets.

Conclusion

The expiration date in a futures contract is the last date for trading that contract. Investors can reduce losses and strive to maximize profits by a rollover, which enables the extension of an expiration date by opening up the same position.

Understanding expiration dates and rollovers help you manage risk and maximize profits to put you on the path of a successful futures trading journey.

Frequently Asked Questions

Q

Is it smart to trade futures contracts near rollovers?

A

Rollover days are periods when the futures markets can be unpredictable. Although traders rely on volatility, rollover dates may not be the best time to trade futures, especially for novice traders.

Q

What is a futures contract expiration date?

A

Futures contracts expire. As the contract nears the end date, it might become less attractive to trade because it converges on the underlying spot price.

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