Expiration of futures – 3 things you should know
Expiration of futures is the process of completion of circulation of a standard forward exchange contract in the exchange market. The expiration date of a futures contract is the last date when this contract could be traded. This date is stated in the specifications of a futures contract. Specifications of a futures contract is an official document, in which the trade organizer (an exchange) sets all parameters of a futures contract and trading rules. Usually, the futures contract expiration date falls on the third Friday of the contract month but could be different for some contracts which has to be stated in their specifications.
Despite the fact that only less than 1% of contracts in the world practice result in real delivery, some traders hold open futures positions until the date of their expiration and perform conditions of the futures contracts. However, the majority of futures traders make profit on the difference between the futures contract prices and do not plan to perform neither cash settlements nor physical delivery under them when they expire.
Understanding of what actions a trader should undertake when the expiration date is approaching refers to the management of open futures positions. A trader has several variants of action before the approach of the expiration date. A trader could either liquidate his futures position or rollover it to the next contract month.
In this article:
- Liquidation or offsetting
- Rollover of a futures position
- Settlement of a futures contract
Liquidation or offsetting
Offsetting (reversing trade) or liquidation of a futures position is the most wide-spread method of exiting from an open position under a futures contract. Offsetting results in termination of obligations under an earlier opened position due to the fact that an opposite position under the same futures contract emerges. As a result, a trader makes either a profit or loss without cash settlements or physical delivery of an underlying asset.
Let’s consider the situation in detail. In order to perform offsetting, a trader who takes a short position would have to buy a futures contract. A trader who takes a long position would have to sell a futures contract. Since all the futures contracts are standardized, this allows the trader to neutralize his obligations resulting from the first futures contract through execution of the second (reversing) futures contract. The second futures contract contains conditions which are opposite to conditions of the first futures contract but has the same expiration date.
For example, a trader who wants to liquidate a short position under two WTI (West Texas Intermediate Crude Oil) oil futures contracts, the date of expiration of which is in September, would have to buy two futures contracts of the same WTI oil with the same expiration date. The difference between the costs of the first two contracts and two offsetting contracts will bring a trader either a profit or loss.
Rollover of a futures position
Rollover of a futures position is the situation when a trader passes from the current futures position with the closest expiration month to a similar futures position with the next expiration month. The trader identifies the time of rollover of his futures position through analyzing trading volumes of both the current contract, which expiration date is approaching, and the new one. The position rollover to the new contract month is often performed when trading volumes under the new futures contract achieve a certain value.
When the futures position rollover takes place a trader simultaneously executes an offsetting (reversing) trade under the current futures position and opens a new futures position with the expiration date in the next contract month.
For example, a trader who holds a long position under four E-mini S&P 500 futures contracts, expiration of which takes place in September, will need to simultaneously sell four E-mini S&P 500 futures contracts with the expiration date in September and buy four E-mini S&P 500 futures contracts with the new expiration date in December.
It is very important to perform all necessary operations simultaneously, when you rollover your futures position to the next contract month, in order to avoid the time gap between the trades, since the time gap between the current position closure and new position opening could result in slippage and potential loss as a result of market movements which took place at that very moment. Usage of this rollover to the next contract month in one transaction reduces the risk of such a slippage.
Long-term traders who have no intention to lose their market positions often use this rollover technique. Now, when you know how to correctly rollover a futures position and manage its expiration, you will feel more confident in trading in the futures market.
Settlement of a futures contract
Settlement of a futures contract is performance of legal obligations on deliveries under this contract. Remember that this is an obligation and not a right, as it is with options, and this obligation has to be performed. Performance of obligations under some contracts takes place in the form of a physical delivery of an underlying asset.
For example, a food producer wants to buy grain and needs a physical delivery of corn and wheat, while a farmer wants to deliver this grain to him. Despite the fact that physical delivery performs an important economic function though linking the futures market of some types of energy resources, metals and agricultural products with their real physical markets, only a small part of commodity futures results in physical delivery.
In the majority of cases, performance of a futures contract takes the form of cash settlement. When a contract is cash-settled, its performance is carried out in the form of granting a credit or writing-off money funds in the amount of the cost of the futures contract after its maturity. The equity index futures and interest rate futures are the most popular financial products under which cash settlements take place. Apart from that, cash settlements could be carried out under the precious metals futures, foreign exchange futures and some agricultural futures.
If a trader hasn’t executed an offsetting (reversing) trade or hasn’t rolled over his futures position until the date of its expiration, he will have to perform his futures contract. In such a case, the trader who took a short position has to deliver the underlying asset in accordance with the futures contract specifications. It could be, as we said before, both a physical delivery of commodities (gold, silver, wheat, corn, coffee, soya beans, etc.) and cash settlements (EUR, GBP, etc.). Besides, the form of physical delivery of the underlying asset will significantly depend on the counter-agent needs and properties of the delivered commodity.
You will always have several variants of actions in the event of expiration of a futures contract when you trade in the futures market. Understanding of how you can manage an open futures position before its maturity positively influences efficiency of your trading.
