Futures contract rollover is a process in which traders or investors transfer their existing futures contracts to a later expiration date. This is done to extend the expiration period of the contract and avoid the obligation of taking physical delivery of the underlying asset.
Futures contract rollover typically applies to commodities, such as oil, gold, or corn, but can also involve other financial instruments, like currencies, stock market indices, or interest rate futures. Futures contracts are standardized agreements between two parties to buy or sell a particular asset or financial instrument at a predetermined price and date in the future. These contracts are traded on an exchange, such as the Chicago Mercantile Exchange (CME) or the New York Mercantile Exchange (NYMEX).
When a futures contract approaches its expiration date, traders have several options. They can either close their position by selling or buying back the contract, take physical delivery of the underlying asset, or roll over their position to a later expiration date. The latter option is the most common choice for speculators and hedgers who want to maintain their exposure to the market without incurring the costs, risks, and inconveniences of delivery.
Futures contract rollover involves three main steps. First, the trader selects a new expiration month or cycle that is farther in the future than the current one. For example, if the trader holds a December 2021 crude oil contract, they may choose to roll it over to a March 2022 contract. This decision depends on various factors, such as market conditions, trading strategy, risk appetite, and liquidity.
Second, the trader closes their existing position by offsetting it with an opposite transaction in the same contract or an equivalent one. For instance, the trader who holds a long (buy) December 2021 crude oil contract may sell it and simultaneously buy a March 2022 contract. This process results in a net zero exposure to the market, but with a different expiration date.
Third, the trader pays or receives the difference in price between the two contracts, which is called the rollover cost or credit. This amount reflects the market`s expectation of the price of the underlying asset at the new expiration date, as well as the supply and demand dynamics of the contracts. Depending on the direction and size of the rollover, the trader may incur a cost or receive a credit. The rollover cost or credit is typically higher for volatile and illiquid markets, such as some commodities or currencies.
Futures contract rollover is a crucial aspect of futures trading because it allows traders to maintain their positions, avoid unnecessary volatility, and adapt to changing market conditions. However, it also involves risks, such as price movements, slippage, liquidity gaps, and rollover costs. Therefore, traders should assess their trading plan and risk management strategy before deciding to roll over their contracts. Additionally, they should stay informed about the market, follow the exchange`s rules and regulations, and use appropriate tools and platforms for efficient and reliable execution.
