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Rolling your futures contracts

As we approach the next triple witching date, March 17th, not only is it an important options expiration. It's also when many futures contracts expire. Thus it is important to consider the implications. But first let's talk a little bit about why futures contracts exist.

The origin of futures

Futures contracts are financial instruments that allow traders to buy or sell an asset at a specific price and date in the future. Futures were created to help manage risk for producers and consumers of commodities, such as farmers and manufacturers, who needed a way to protect themselves against price fluctuations. These contracts are standardized agreements that are traded on exchanges, with each contract representing a specific quantity of the underlying asset.

Futures contracts have expirations on regular intervals, usually monthly or quarterly. At expiration, traders must either take delivery of the physical commodity or settle the contract in cash. Because futures have a fixed expiration date, traders need to roll over their positions before the contract expires to avoid taking delivery of the underlying asset. Rolling over a futures contract involves closing out the current contract and opening a new one with a later expiration date.

When to roll futures contracts

One way to determine when to roll over a futures contract is to use volume on the new contract. Volume is a measure of how much trading activity is taking place in a particular market. I like to monitor the next expiry and see when volume begins to shift to it meaningfully in order to plan my contract roll. Once more volume is trading on the next expiry that's when I begin to roll my positions. Volume can provide a way to assess the liquidity of the market, which is important for ensuring that traders can buy and sell contracts at fair prices.

For example, let's say a trader has a long position in a crude oil futures contract that expires in June. As the June contract approaches expiration, the trader needs to decide whether to roll over the position to the next contract, which would be the July contract. To make this decision, the trader can monitor the volume on the July contract. If the volume on the July contract starts to surpass the volume on the June contract, it may be a sign that other traders are also rolling over their positions and that it's time to do the same.

Rolling is really just an industry term that means closing out the positions that are set to expire and opening the same positions, if desired, in the next contract with the next expiration. The failure to do so can lead to unintended consequences, such as having a cash settlement or, worse, in some situations the physical delivery of commodities.

It's best to check with your broker to ensure that if you do not wish to have physical delivery that you are not at risk of having that happen should you fail to close a position in time. Many brokers already restrict this by default.

In closing

Futures contracts are an important financial instrument that allow traders to manage risk by buying or selling assets at a specific price and date in the future. Futures contracts have expirations on regular intervals, and traders need to roll over their positions before expiration to avoid taking delivery of the underlying asset.

Using volume on the new contract can be a useful way to judge when to roll over futures contracts, as it provides an objective measure of market activity and can help traders identify trends and patterns in the market.

1 Comment

Mar 15, 2023

I always wondered if future contract roll was something more seamless and integrated. Sounds like it isn't and exactly what I have been doing all along. Thanks for sharing.

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