As you decide to enter the realm of futures trading, you must update yourself on all aspects of future trading strategies. In the world of futures, expiration and rollover are the two most important terms. Futures contracts have a limited lifespan; rollover in futures contracts allows traders to extend the lifespan when they expect a strong trend in their favour.
Alternatives when a future nears expiration
Before discussing rollover, let’s understand the alternatives available to a futures trader when a futures contract expires.
When a futures contract is close to its expiration date, the trader can offset, rollover, or settle the position.
Offset a position
The trader must carry out an equal and opposite transaction to neutralise a position. For example, a trader short on two future contracts expiring next month must purchase two long agreements to offset the situation. The difference in price between the earlier and the newly opened positions will determine profit or loss in the trade.
Rollover is another alternative available to traders where they can extend the expiry of the futures. Traders need to decide when to roll over after observing the volume of the expiring contract and the next-month contract when it reaches a certain level. The rollover will offset the current position and open a new one for the trader.
Settlement is the most straightforward option. Settlement occurs when the trader doesn’t opt to offset or roll over the expiring contract.
You have choices regarding the outcome of a futures trade. Knowing your options around rollover and expiration is critical since those will determine the final profit from the futures trade.
How does the rollover work?
Futures are financial contracts with a fixed expiration date. Rollover is the opposite of expiration. It involves replacing a near-month contract close to its expiry with another contract with an expiration date later. Traders usually roll over when they are bullish or bearish on the trade to extend their position. It is done close to the expiration date.
Determining the rollover cost is critical, which is the value of the mid-month and far month’s open interests divided by the sum of the current, mid, and far month’s open interest, multiplied by 100. Rollover percentage gives traders a fair idea about the strength of a prevailing trend.
Let’s understand with an example.
You hold a long position on the futures contract of NIFTY 50 that expires in June. On the day of expiry, you realised the future to rally further and opt for rollover instead. If the rollover percentage from the previous month to the current month is 70 and from the current month to the next month is 80, along with an increase in the futures’ price, it indicates a bullish trend. So, to decide whether or not to roll over, a trader must consider the rollover percentage in conjecture with the price contract.
Why rollover doesn’t happen in options
Rollover is typically associated with futures and not options because of the inherent character of the latter. Unlike futures, options are non-obligatory. Hence, an option owner can walk out of a trade at any point before its expiry and open a new position when liquidity is high.
Rollover in India
In the Indian market, futures contract settlement happens on the last Thursday of every month. If Thursday is a holiday, the settlement occurs on Wednesday. The window for rollover opens a week before the contract’s expiration date and lasts till the closing of the trading hours on the expiration date. The process takes place at the trading terminal through the spread window. It is possible to roll over the expiry date to the next month. The trader can do so by keying in the spread in the trading terminal.
Rollover is a critical financial decision, and it is essential to know the risks involved with the choice. The primary risk is the leverage associated with it. Improper use of margin leverage can magnify your losses. Hence, it needs to be handled with caution.
Rollover in the stock market is an option that traders can use when they anticipate a solid trend to improve their position in the near future. However, they must keep in mind that an open position in the market for a longer time also increases the risk quotient. Hence, they must ensure that the market will move in their anticipated way before rolling over.
Disclaimer: Angel One Limited does not endorse investment and trade in cryptocurrencies. This article is only for education and information purposes. Discuss with your investment advisor before making such risky calls.