In the trading of futures, "rollover" refers to the process of closing out open positions in soon-to- expire contracts in favour of contracts with later expiration dates. Rollover is unique to each product, and it produces a substantial impact upon volatility and price action within the marketplace.
The days surrounding an individual contract's rollover are especially important in the area of risk management. The full attention of investors engaged in trading expiring contracts is required, as unique challenges are presented via split volume and reduced market liquidity.
Rollover is a key aspect of futures trading that must be accounted for, as it directly impacts the bottom line of the trading account.
Expiration And Roll Date
Futures contracts are financial products priced according to the value of a specific quantity of an underlying asset over a fixed period of time. Because a futures contract is finite in duration, there are a few key dates that active traders need to be aware of:
- Expiration day: The last day that a futures contract is binding. After expiration, a futures contract is no longer valid.
- Last trading day: The last day when a futures contract can be traded. After the last trading day, delivery of the underlying asset or cash settlement must transpire.
The period of time before a contract's expiration in which investors close positions in favour of contracts with further-out expirations is known as the "roll date." Roll dates are unique to each type of contract being traded and vary in duration. For instance, the Emini S&P futures contract has a typical roll date of eight days before expiration, while the Nikkei 225 generally has a roll date of the first Monday of the expiration month. Futures markets are fluid in nature, thus a contract's roll date is not necessarily concrete and is subject to change on an ongoing basis.
It's important to understand the relationship between the roll date, expiration date and the last trading day. The roll date is not a scheduled date; it represents the time in which the process of rollover typically commences. Expiration and last trading day are the exact dates in which a contract becomes invalid for trade and all positions in a given contract are closed.
Volume Splits And Liquidity
During the days surrounding the roll date, trading volumes tend to become split between the expiring contract and contracts expiring further in the future. The split in volume can have a substantial impact upon short-term liquidity and render difficult intraday trading conditions.
The result of decreased volume has two effects upon the market:
- Increased bid/ask spread: As the number of market participants decreases, the spread between buyers and sellers gets larger. In turn, entering and exiting the market becomes a more costly proposition.
- Slippage: A decrease in the number of buyers and sellers placing market orders at each price reduces market liquidity and greatly increases the chance of experiencing substantial slippage upon market entry and exit.
The period surrounding contract rollover in a specific futures market can be a challenging time for traders. Decreasing volume due to attention being shifted to other futures contracts poses several potential hazards, and many professional traders avoid rollover altogether.
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