All derivative contracts have an expiry date. The life of a future is a maximum of 3 months. All the near-month contracts on Futures & Options expire on the last Thursday of the respective month. Traders entering a contract must abide by their terms on or before the expiry date. However, they also have the option to carry forward their contracts to the coming months. This move is termed the rollover of futures contracts.
In this blog, we will learn about the Futures Rollover, how it works, and how traders can utilise this rollover feature. So let's get started.
What is Rollover?
A rollover means carrying forward your future positions from closing your positions near the expiry date to opening the same new position in a further-out-month contract.
In simpler words, the process of carrying forward your position from one month to another month is called a rollover.
On the expiry date, a trader can enter into a similar contract expiring at a future date or let their position lapse on that date.
Rollover can only occur in the case of futures and not options. Here’s an example to understand rollovers:
Let's imagine that you have high hopes for Tata Steel as a result of an increase in steel prices throughout the world. As a consequence, you purchased Tata Steel March futures intending to hold them until expiration. The stock increases by Rs. 20 just before it expires, but in your opinion, it might rise much more. What choices do you have in front of you? You have three possibilities available to you if you keep a long position in the future, as shown below.
You might choose to close out your investment and book profits in the March Tata Steel Futures by selling futures of equivalent quantity.
You can also choose to let your futures expire if there is very little liquidity in the futures market. The difference between the closing price and the purchase price will be automatically credited to your trading account on the settlement day, which is the last Thursday of each month.
You can also decide to roll over your long futures into the April contract as a third option. In essence, you sell your March Tata Steel Futures and buy April Tata Steel Futures at the same time.
How do contracts work and roll over in India?
In India, the settlement of contracts takes place on the last Thursday of every month. If that is a holiday, contract settlement takes place on Wednesday. The rollover is completed till the close of trading hours on the expiry day; a part of the rollover begins one week before the expiry. The rollover process takes place on the trading terminal through a spread window.
If any individual holding a futures contract of one month wants to carry forward the position to the next month, it is possible. The investor can do so by keying in the spread at which he/she wants to roll over the position in the coming month.
Why Can’t Rollovers Happen in Options?
There is no possibility of rollover happening in options. This is because futures are mandatorily exercised on expiry, whereas options may or may not get executed. Since an options contract is asymmetric, the pricing is complex. Generally, traders leave options to expire; they take fresh positions when there is liquidity.
What are the different strategies of F&O trading?
In the future, the strategies are not too many. You can use futures to speculate, hedge, or arbitrage in the market. Futures can be hedged by buying lower put options that are called protective puts. Alternatively, you can hold on to the cash market position and sell higher call options, which is called the covered call.
Then there are volatile strategies like strangles. Here you don’t bet on markets going up or down but just bet on volatility increasing or decreasing. In strangle, you make profits either way since you buy a call and a put. Then there are variants like butterflies, collars, straddles, bull call spreads, bear put spreads, and the list of strategies can go on.
What dangers do futures contracts pose?
The inherent element of leverage in futures trading is one of the largest dangers involved. A 20% margin on futures is equivalent to receiving five times the leverage. This has the potential to five-fold both your gains and your losses. Losses in futures trading are sometimes caused by a lack of understanding of leverage and the dangers it entails. There is a danger that the price will move against you. Not to be ignored is the risk that MTM margins pose to liquidity and solvency.
Individuals can employ futures rollover when they believe there is a chance to strengthen their position in the near future. Rollover traders, on the other hand, must be certain about how the market will behave in the future months, or they risk losing a lot of money.