Understanding futures expiration and contract roll
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The lifespan of a futures contract
Futures contracts have a limited lifespan that will influence the outcome of your trades and exit strategy. The two most important expiration terms are expiration and rollover.
Contract expiration options
A contract’s expiration date is the last day you can trade that contract. This typically occurs on the third Friday of the expiration month, but varies by contract.
Prior to expiration, a futures trader has three options:
- Offset the position to fully close out the trade
- Roll the contract from the current, or forward, month to a future expiration date
- Let the contract expire and take delivery
Offset the postion
Offsetting or liquidating a position is the simplest and most common method of exiting a trade. When offsetting a position, a trader is able to realize all profits or losses associated with that position without taking physical or cash delivery of the asset.
To offset a position, a trader must take out an opposite and equal transaction to neutralize the trade. For example, a trader who is short two WTI Crude Oil contracts expiring in September will need to buy two WTI Crude Oil contracts expiring on the same date. The difference in price between his initial position and offset position will represent the profit or loss on the trade.
Rollover is when a trader moves his position from the front month contract to another contract further in the future. Traders will determine when they need to move to the new contract by watching volume of both the expiring contract and next month contract. A trader who is going to roll their positions may choose to switch to the next month contract when volume has reached a certain level in that contract.
When rolling forward, a trader will simultaneously offset his current position and establish a new position in the next contract month. For example, a trader who is long four S&P 500 futures contracts expiring in September will simultaneously sell four Sept ES contracts and buy four Dec or further away ES contracts.
If a trader has not offset or rolled his position prior to contract expiration, the contract will expire and the trader will go to settlement. At this point, a trader with a short position will be obligated to deliver the underlying asset under the terms of the original contract. This can be either physical delivery or cash settlement depending on the market.
You have choices when it comes to your futures positions at expiration. Knowing how you want to manage your trades around rollover and expiration is important as it will directly impact the outcome of the trades.
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