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

Nonfinancial 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.

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