A:

Traders roll over futures contracts to switch from the front month contract that is close to expiration to another contract in a further-out month. Futures contracts have expiration dates as opposed to stocks that trade in perpetuity. They are rolled over to a different month to avoid the costs and obligations associated with settlement of the contracts. Futures contracts are most often settled by physical settlement or cash settlement.

Physical Settlement

Non-financial commodities such as grains, livestock and precious metals most often use physical settlement. Upon expiration of the futures contract, the clearinghouse matches the holder of a long contract against the holder of a short position. The short position delivers the underlying asset to the long position. The holder of the long position must place the entire value of the contract with the clearinghouse to take delivery of the asset.

This is quite costly. For example, one contract of corn with 5,000 bushels costs $25,000 at $5.00 a bushel. In addition, there are delivery and storage expenses. Thus, most traders want to avoid physical delivery and roll their positions prior to expiration to avoid it.

Cash Settlement

Many financial futures contracts, such as the popular E-mini contracts, are cash settled upon expiration. This means on the last day of trading, the value of the contract is marked to market and the trader’s account is debited or credited depending on whether there is a profit or loss. Large traders usually roll their positions prior to expiration to maintain the same exposure to the market. Some traders may attempt to profit from pricing anomalies during these rollover periods.

RELATED FAQS
  1. Forward Contracts vs. Futures Contracts

    While both forward and futures contracts allow people to buy or sell a specific asset at a specific time at a given price, ... Read Answer >>
  2. How are futures used to hedge a position?

    Futures contracts are one of the most common derivatives used to hedge risk. Learn how futures contracts can be used to limit ... Read Answer >>
  3. How is the price of a derivative determined?

    Learn how different types of derivatives are priced, including how futures contracts are valued and the Black-Scholes option ... Read Answer >>
Related Articles
  1. Investing

    A Quick Guide for Futures Quotes

    Here is a quick guide for reading and understanding futures markets quotes.
  2. Trading

    The Difference Between Forwards and Futures

    Both forward and futures contracts allow investors to buy or sell an asset at a specific time and price.
  3. Investing

    Is USO a Good Way to Invest in Oil?

    The United States Oil Fund is better suited to short-term investors who actively manage their portfolios.
  4. Investing

    How to Trade Futures Contracts

    Futures is short for Futures Contracts, which are contracts between a buyer and seller of an asset who agree to exchange goods and money at a future date, but at a price and quantity determined ...
  5. Trading

    Futures Fundamentals

    This tutorial explains what futures contracts are, how they work and why investors use them.
  6. Investing

    What is a Forward Contract?

    A forward contract is a customized contract between two parties to buy or sell an asset at a specified price on a future date.
  7. Trading

    Forward Contracts: The Foundation Of All Derivatives

    An investor can assess interest rate parity and implement covered interest arbitrage by using a currency forward contract to generate risk-free returns.
  8. Investing

    Currency futures: An introduction

    The forex market is not the only way for investors and traders to participate in foreign exchange.
RELATED TERMS
  1. Last Trading Day

    The last trading day is the final day that a futures contract ...
  2. Forward Contract

    A customized contract between two parties to buy or sell an asset ...
  3. Cash Contract

    A cash contract is a financial arrangement that requires delivery ...
  4. Contract Unit

    A Contract Unit is the actual amount of the underlying asset ...
  5. Contract Size

    A contract size is the deliverable quantity of commodities or ...
  6. Quadruple Witching

    The expiration date of various stock index futures, stock index ...
Hot Definitions
  1. Economies of Scale

    Economies of scale refer to reduced costs per unit that arise from increased total output of a product. For example, a larger ...
  2. Quick Ratio

    The quick ratio measures a company’s ability to meet its short-term obligations with its most liquid assets.
  3. Leverage

    Leverage results from using borrowed capital as a source of funding when investing to expand the firm's asset base and generate ...
  4. Financial Risk

    Financial risk is the possibility that shareholders will lose money when investing in a company if its cash flow fails to ...
  5. Enterprise Value (EV)

    Enterprise Value (EV) is a measure of a company's total value, often used as a more comprehensive alternative to equity market ...
  6. Relative Strength Index - RSI

    Relative Strength Indicator (RSI) is a technical momentum indicator that compares the magnitude of recent gains to recent ...
Trading Center