Last week was a big week for futures traders. Thursday and Friday were rollover days in the futures market, the time of the month where futures traders move their positions from current month contracts to contracts further into the future.
Here’s a look at what futures rollover is and what it means for the market.
A contract’s final day of trading prior to expiration is called its expiration date. Expiration dates are typically the third Friday of the expiration month, but expiration dates vary from contract to contract.
When an expiration date is approaching, futures traders have three choices of what to do with their open positions. First, traders can choose to offset their position. To offset a position, traders must buy one long contract for every short contract (or vice versa) to create an overall neutral position.
Second, traders can opt to settle their position by paying cash for the underlying asset or by delivering the underlying asset if they have a short position. The average retail trader is rarely looking to buy or sell actual barrels of crude oil, for example, so settlement is typically not an ideal option.
Finally, futures traders can opt to maintain their futures trades by rolling over their contracts.
Futures traders roll over their expiring contracts by simultaneously taking a similar stake in a contract with an expiration date further into the future and offsetting the current-month contracts. The next expiring contract for a particular asset is typically referred to as the “lead contract” or the “front month” contract. Rolling over to the lead contract allows traders to essentially maintain their original position without dealing with expiration.
Traders who want to rollover their positions must be careful to make sure they are buying and selling the correct contracts. If the expiring contract is not offset fully and properly and/or if the forward-month contract does not match the expiring one, it could create a huge mess.
Futures codes are similar to stock tickers but are slightly more complicated. A futures code contains an abbreviation for the type of contract followed by a letter denoting the month the contract expires and a number indicating the year. A full breakdown of futures contract codes can be found here.
On or around futures rollover dates, the majority of volume in the futures market shifts from the current month to the next contract month as of the market open on rollover day. Experienced traders know trading action follows the volume, so it’s important to be aware of upcoming expiration dates and their impact on the market. Some traders opt to avoid trading on rollover day altogether due to the extreme volatility and unpredictability that can often be associated with the heavy trading volume.
There are plenty of online calendars that keep traders informed of upcoming expiration dates, such as the CME Group expirations calendar here.
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