Futures Contract Rollover Explained

Every March, and other quarterly months (June, September, and December), futures contracts that track interest rates, currencies and the stock index futures end their contract life, expire and come up for settlement. This necessitates the need for traders who are holding positions in these markets to exit these contracts and roll them over to the next quarterly month.

This futures contract rollover is unique to the futures market. To someone new to trading these markets the phenomenon can sometimes be confusing.  Because March is the end of the quarter, the “Rollover” event is happening throughout the month across most futures contracts, particularly in the financials since they expire quarterly. We tend to get many questions from our newer futures traders regarding this topic, and although I’ve written about this subject in the past, I think it’s worth revisiting. In this article, I’ll attempt to demystify and, more importantly, simplify this rollover occurrence.

Futures

Because futures contracts are an obligation between buyers (to take delivery) and sellers (to deliver) the underlying commodity or financial product, the contract must settle and therefore expire. The normal life span of most futures contracts varies widely, but that isn’t as important to a trader as it is to know when to switch from the expiring contract to the new “front” month contract which is always the most liquid contract.

Two Reasons to Switch to the Front Month Contract

There are two primary reasons that a trader needs to switch from the contract that’s going off the board to the front month contract.  The first is that liquidity in the expiring contract starts to dry up immediately after rollover day, and with that, spreads become wider which would lead to trades becoming more prone to slippage. Secondly, if a trader holds on to an expiring contract after the first notice date (the date in which a trader may be required to accept delivery) it may cause all sorts of headaches for the broker, not to mention the trader himself. This is especially true in those contracts in which the deliverable product is an actual physical commodity such as oil, corn or gold.  This is why it’s imperative to know when this date occurs.

As previously mentioned, the financials (equity indexes, interest rates and currencies) all carry quarterly expiration, which makes it easier for a trader to remember.  All of the traditional commodities and the like rollover more frequently because many producers (food companies, airlines, farmers) use these contracts as a way to hedge against their cash crops or physical production.

The most important date for traders is the first notice date which is the day he is put on notice that expiration is nearing and he must trade to close out of the expiring contract or offset the position.  A trader must rollover the expiring contract a few days in advance of the expiration. The CME provides an expiration calendar, plus an explanation for terms.   The products are grouped by sector. To get to the calendar, simply find the specific futures contract and click on the product name link which will take you to the contract specifications page where you will see the calendar tab.

Lastly, rollover day is different for all of the different contracts. In other words, the number of days before expiration when a trader needs to exit one contract for another varies among the different futures contracts.  Below is a list of the groups and days prior to expiration when rollover occurs:

  • Equity indexes –  7 days

  • Currencies -3 days

  • Interest Rates- 14 days

  • Metals-20 days

  • Grains -10 days

  • Energy-3 days

With this information, you simply check the product calendar at the beginning of every month and prepare to make the switch from one contract to the next. In addition, most brokers send out two or three notifications to this effect to all their customers. It’s as simple as that.  It’s just an extra step, but a necessary one when you’re trading futures, which in my humble opinion are the best markets in the world.

Until next time, I hope everyone has a great trading week.

This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results.