How To Trade Futures Contract Rollover

Trading a futures contract rollover can be tricky business, before we explore the does and don’ts of trading on roll over day, let’s first understand what roll over means

An Agreement
A Futures contract as the name implies is an agreement by two parties, the buyer and seller to exchange a commodity at a later date.

Getting Flat
Anytime prior to the Expiration date of the futures contract either party may also exit their position by taking the other side of the trade. i.e sell a contract if they are currently holding one, or buy back a contract if they are currently short, making them flat in the market.
Anyone still holding a position at expiration must either Deliver to the buyer (in the case of a short position) the commodity, or Take Delivery (in the case of a long position) of the commodity.

Speculation not an Investment
As speculators in the futures and commodity markets it goes without saying that we never want to have a position on at expiration as our goal is to profit from incremental moves in price and never to take possession of the underlying commodity.

There are also what is known as cash settled commodities, where rather than take actual possession the traders account is imply offset by the value of the contract versus his or her position. (we will leave that discussion for another time)

How to trade on Contract Roll Over Day.
Contract roll over day brings many new risks to speculative traders that most other trading days do not.
Simply put it is 1 or 4 days of the year (actually 3 days of 12 as the effects of roll over tend to last for 3 days) when all the larger institutional traders Must come to the market and adjust their positions. On every other trading day the institutional traders can chose to trade or not trade, however on roll over this is not the case. As contracts will expire and cease to exist, they therefore must adjust, or "Roll" their contracts forward into new contract months.

In addition, knowing that the institutions will be present and active, there exists a group of traders who specifically take advantage oh this dynamic. They are called Spreaders.
A spreader will take a position in both the back month and front month, (the outgoing and incoming contract) in order to scalp or play the spread between the two.
Spread trading requires a very specific skill set and is not for the average day trader or fain of heart.

Contract roll over day, will act differently than most other trading days, and the reasons why have just been explained above. The influence of large institutional trading coupled with spread traders makes navigating the landscape more challenging than other trading days.

Can a trader still actively trade roll over?
Yes, why not. The liquidity will still be there, and volumes will most likely be greater

Will the same trading setups work on roll over?
Unlikely, and this is where many traders get hurt. The market will have a particular 2 sided nature, (moving in both directions) due to the effects of the institutions and the spreaders.

When is it safe to resume trading?
Watch the volumes in the back month and the front month. When the trade volume for the new contract is significantly greater than the old outgoing contract, it is generally the sign that the majority of the roll has taken place

 For more information on trading OPEX, (Options Expiration) see this post

Category: Trading Articles