How do Futures Contract Rollover Days Work?

How do Futures Contract Rollover Days Work?
The rollover day for a futures contract is one of the most misunderstood features in trading these contracts. The expiration day is easily understood. It occurs on the third Friday of each quarter month, that is March, June, September, and December. That day is when the futures contract must be settled.

However, the fact is that futures are a trading tool, a derivative which gives excellent leverage to your money, and the actual expiration date does not really represent the mass of activity that you might expect. Instead, a great deal of the activity takes place on the rollover day, which is generally eight days before expiration.

The underlying contract for a futures trade would require a physical delivery, and to avoid this the normal process is to close out the contract, which basically means make a financial settlement, in advance of the designated expiration date. An alternative to closing the contract is to roll it over into the next quarterly period if you want to keep the trade open.

You may have a choice on rollover in some markets. In the Forex markets, the rollover will happen automatically. For regular futures, your broker may offer automatic rollover, and this will take place eight days before expiration date. Other markets, such as those in the UK, have different standards.

You may have heard about difficulties with liquidity, and increased volatility associated with rollover days. These result from the changeover that happens. Most traders move from trading the current contract into the next contract, and that means that the volume of the expiring contract becomes less, usually resulting in larger spreads, and the trading volume for the next period increases.

The expiring contract can still be traded, as it is still available up to the expiration day, but generally the liquidity will suffer and you are best advised, if you want to continue in this position, to change to the new contract. This will avoid the problems associated with reduced trading volume. The big shift in volume happens at 9:30 EST on rollover day.

The increasing spreads on the expiring contract can be harmful to you if you daytrade, and the new contract will usually have very tight spreads on the rollover day. This is also important if you are a longer-term trader who wants to carry the contract past the expiration date, as the small spreads mean that you will pay the least to do the transfer. If you are considering opening a position within a few days of rollover day, then you may find it better to use the new contract at the start.

For reasons given above, you'll find that the trading environment is better if you switch from trading one contract to the next on rollover day. The only possible exception is if you are considering opening and closing your position on the same day, when you might open on the expiring contract -- but you would need to keep in mind the effect on the spreads that the mass move over to the new contract will have.