Futures and options trading is a popular method among seasoned traders. It helps traders and institutions to hedge their positions or take speculative bets on the price movements of stocks in the future.

A key characteristic of derivative contracts is their fixed expiry date. But what happens when a trader wants to extend their position beyond the expiry date? This is where rollovers come into play. Rollovers are a practical solution to carry forward a position into the next contract cycle.

In this article, see how futures rollovers work in India and how they affect your trading strategy.

• Rollover extends derivative positions beyond contract expiry by switching to new ones.
• Rollovers only apply to futures contracts; options contracts cannot be rolled over.
• Market conditions influence rollover costs, which can vary between contracts.
• Managing leverage and liquidity risks is essential to prevent heavy losses in futures trading.

A rollover is the transfer of an existing position in a futures contract that is nearing expiry into a contract that expires in the month. It involves closing an existing futures position and simultaneously opening a similar position in a new contract that has a later expiry date. This lets traders maintain uninterrupted exposure to a particular asset.
 

Rollovers are common in futures trading. They help traders extend their positions when they anticipate further price movements. It is important to note that rollovers are exclusive to futures contracts; options cannot be rolled over due to their different dynamics and settlement processes.

To illustrate the concept, let's consider a simple example. Assume that Seema holds 200 lots of HDFC futures that are expiring at the end of the current month. She anticipates further gains in the stock price in the coming month. Instead of closing her position entirely, Seema sells her current futures contracts and simultaneously buys an equal quantity of HDFC futures set to expire next month. Such a move is called a "long rollover."
 

On the other hand, if Ravi is holding a short position in ICICI futures and expects the price to drop further next month, he would "short rollover" his position by closing the current month’s contracts and opening a new short position for next month’s expiry.
 

The key point in a rollover transaction is that the position remains the same (long or short), but it simply extends the position to the next contract period.

In India, futures contracts expire on the last Thursday of the month. If that Thursday is a holiday, the contracts expire on the Wednesday preceding that day. Traders who want to roll over their positions have to complete the process before the end of trading hours on the expiry day. However, most traders begin rollovers on their contracts a week before expiry to ensure liquidity and minimise slippage.
 

The rollover process is straightforward, and it can be executed over a trading terminal's spread window. The trader specifies the spread they are fine with between the current contract and the next one. The rollover cost (also called spread) is the price difference between the near-month and far-month contracts. It is influenced by factors like market sentiment, demand, and interest rates.

Unlike futures, options contracts cannot be rolled over. The main reason is that options need not be exercised upon expiry. This makes them fundamentally different from futures. In addition, options pricing is more complex because of the asymmetry between buyers and sellers. Traders generally let options expire or take fresh positions in new contracts with the desired expiration date.
 

Instead of rollovers, option traders tend to close their existing positions and open new ones in subsequent contracts in case they want to maintain their exposure to a particular security. This process is called a re-entry into a new trade, and not a rollover.

Futures trading comes with substantial risk, primarily because of the leverage involved. When a trader enters a futures contract, they need to deposit only a margin (which is usually 10-25% of the contract value), but they are exposed to the full value of the contract. This leverage amplifies both gains and losses.
 

For instance, if you hold a position with a 25% margin, any price movement delivers four times the profit. However, adverse price movements can cause equally bigger losses and sometimes wipe out the entire margin.
 

Price volatility and low market liquidity represent some other major sources of risk. If a contract has low liquidity, there might be a significant ask-bid spread, which causes poor execution prices when you roll over or exit trades. That is why traders must manage their risks carefully by using strategies like stop-loss orders, diversifying the portfolio, and regularly monitoring market conditions.
 

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Rolling over futures allows traders to maintain their positions beyond the contract expiry. This makes it a useful tool for those with a long-term market outlook. Although the process is simple, it is important to know the costs involved and how to manage risks in futures trading.

Understanding the mechanics of rollovers and how they fit into your broader strategy can help you optimise your futures trading approach while managing potential risks effectively.