If you aspire to be an F&O (Futures and Options) trader, you may want to quickly understand the simple concept of rollover and how futures rollover work.
Since futures are an exchange-traded standardised product, you get three standard contract series options—current month contracts, next month’s contracts, and far month contracts.
As time passes, the next month's contracts become current-month contracts and respectively far-month contracts become next-month contracts.
Does that affect your open position? Yes, of course. That’s where futures rollover comes into the picture.
What is a rollover and how to rollover futures?
Rolling over a futures contract is a two-step process meant to help futures traders to carry over their existing positions by smoothening out the effects of a contract expiry. In plain English, rollover means closing the existing contract nearing expiry and simultaneously opening the same position in a new contract having a distant expiry.
For instance, say you bought an Infosys Futures contract (lot size of 600 shares) at Rs 1,498 with 29th December 2022 as its expiry, on 22nd December 2022. Instead of squaring off your position in Infosys Futures, you decided to roll it over to the 25th January 2023 contract series, on 26th December 2022.
This involved closing your December contract at say Rs 1,518 and simultaneously buying the January 2023 contract at say Rs 1,527.
The price differential in the first leg of the trade is your profit [(Rs 1,518 – Rs 1,498) X 600 shares] and that in the next leg of the trade is your rollover cost which is Rs 9 or 0.59% in this case (Rs 1527 – Rs 1518).
Suppose your initial position in the 29th December 2022 contract was short, closing that trade would mean buying the December future and rollover therefore, would mean simultaneously selling the 25th January 2023 futures contract. In that case, in the previously discussed example, you might have made a loss on your December 2022 Infosys Futures. [(Rs 1,498 – Rs 1,518) X 600 shares]
Contracts that remain unsettled at expiry are compulsorily settled by delivery.
Is it always possible to rollover futures contracts?
The answer in one word would be no. Stock exchanges place F&O contracts on individual stocks under a ban when the total open interest; i.e. aggregate open interest of all F&O contracts for all the months, reaches a level of 95% of the Market-Wide Position limit (MWPL). Open Interest (OI) denotes the number of outstanding contracts. For a ban to get lifted, OI must fall below 80% of MWPL.
This F&O ban is a regulatory mechanism created to discourage excessive speculative activity that may result in price manipulations.
What happens when an F&O contract is under a ban?
Note: We at Ventura update the list of F&O contracts that are under a ban every morning for the convenience of our investors.
In a nutshell
When your view on a stock or an index doesn’t change from one expiry to another, rollover is the best option provided you can bear the rollover costs and bring in adequate margins to hold out your position in the new series.
Also read: How can Futures and Options be used for hedging?
Disclaimer:
The blog is for information purposes only and anything mentioned herein shouldn’t be construed as a fundamental reason to buy/hold/sell any stock. Furthermore, the information provided in the blog and observations made there shouldn’t be treated as the extension of recommendations made on the other properties of Ventura Securities. If you follow any research recommendations made by our fundamental or technical experts, you should also read associated risk factors and disclaimers.
We strongly suggest you consult your financial advisor before taking any decision pertaining to your finances.
We, Ventura Securities Ltd, (SEBI Registration Number INH000001634) its Analysts & Associates with regard to the blog article hereby solemnly declare & disclose that:
We do not have any financial interest of any nature in the company. We do not individually or collectively hold 1% or more of the securities of the company. We do not have any other material conflict of interest in the company. We do not act as a market maker in the securities of the company. We do not have any directorships or other material relationships with the company.
We do not have any personal interests in the securities of the company. We do not have any past significant relationships with the company such as Investment Banking or other advisory assignments or intermediary relationships. We are not responsible for the risk associated with the investment/disinvestment decision made on the basis of this blog article.
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