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Futures Expiration: Summary
Futures Expiration - Definition
The day when the life of a futures contract ends and is to be resolved according to the terms of delivery of the futures contract.
Futures Expiration - Introduction
Futures Expiration date, also known as maturity date, is the day when a futures contract stops trading. Like all financial derivatives, futures have a finite lifespan and both parties still holding in the futures contract through expiration date is expected to fulfill the terms of the contract and either exchange the actual underlying asset (physical settlement) or the cash difference (cash settlement).
This tutorial shall explore the implications of futures expiration day in futures trading and the actions that can be taken for managing expiration of futures contracts.
When Does Futures Expire?
There is technically no such thing as an "Expiration Day" in futures trading. Most often in futures trading, the "Expiration Month" and the "Final Trading Day" or "Last Trading Day" are specified. There is technically no expiration date being specified. Every futures contract matures or expires after the Final Trading Day of the Expiration Month. For instance, the March Single Stock Futures (SSF) for AAPL expires at the end of the final trading day on the Third Friday of April.
There are also times when the term "Expiration Date" and "Final Trading Day" means the same thing (As in the US market). This is a little confusing for beginners to futures trading as the term "Expiration Date" makes them wonder if trading of a futures contract is still possible on that day while the term "Final Trading Day" makes it very clear that it is the final day which trading of a particular futures contract is possible.
In the US market, Single Stock Futures and index futures expire on the third Friday of every contract month (Expiration Month) available while the famous Nikkei 225 futures expires every second Friday of the month with Final Trading Day on the business day preceding that day. Yes, futures expiration date varies according to exchange and market. In fact, the terms "Expiration Date" and "Final Trading Day" can mean different things in different markets. As such, you must be aware of the specific expiration date and/or final trading day for the futures contract you are trading to prevent holding a position through expiration unintentionally.
In fact, all exchanges or clearinghouses publishes specific futures expiration date calendars which specifies exact expiration dates for each of their futures products. You are encouraged to keep close tab on the futures expiration calendar of the exchange or market you are trading in.
What Happens on Futures Expiration day?
At the end of the final trading day, a process known as the Final Settlement happens. Final settlement is simply a process to determine the final price that the underlying asset is to be exchanged hands between the parties involved. By this time, the futures contract can no longer be sold or offsetted in the exchange or open market and that the terms of the contract have to be honored by the parties involved in terms of delivery.
In physically delivered commodities futures trading, futures expiration day is followed by the First Notice Day where a notice known as the Notice of Intent is sent by the Seller (the short in a futures contract) to the clearinghouse and then from the clearinghouse to the buyer (the long in the futures contract) as a formal notification for the exchange of the underlying asset in accordance to the terms of the futures contract.
In single stock futures trading, futures expiration is followed by the automatic delivery of the underlying stock from the short to the long after three business days.
For cash settled futures contracts, profits and losses are settled between the long and the short for a last time during the final settlement process after on the final trading day and then the futures contract closes. There are some exchanges that collects losses from the losing party during final settlement on the final trading day and then disburses profits to the winning party on the day following final trading day and calls it the Expiration Date. As such, you must be very clear about the specific use of terms in the market or exchange you are trading in.
What Can You Do When Futures Expiration Day Approaches?
There are three decisions you can make as futures expiration day approaches; Offset, Roll or Settlement.
Offsetting a futures contract means closing it by going into an equal and opposite transaction. This is the standard way of closing all futures positions and is also the most common action taken by futures traders prior to expiration day. By offsetting your position, you are closing it and realizing all profits or losses and to have no further involvement in that position. If you choose to offset your futures position, you must do so by Final Trading Day, which is typically the day before its expiration date. If you fail to offset your position by final trading day, you will go into the actual settlement of the futures contract. Some exchanges or markets allow you to still offset your position after expiration date but before what is known as a "Close-Out Date". If you are not sure if you are entitled to do so, the safest bet would be to offset the position by Final Trading Day. Read all about Offset.
Rolling a futures position forward means closing off the expiring futures position and then going into a similar futures transaction for a further expiration month. Futures traders do this when they wish to remain in a position for a longer period of time. Rolling forward a futures position is a transaction that simultaneously closes the current position and opening the new position for the price difference. This is different from first offsetting the current futures position and then opening a new further month futures position as there would be a time difference and a break in continuity of the position. Read all about Roll Forward.
By holding a futures position through expiration, you would be legally binded by the futures contract to resolve the contract in accordance to its terms of delivery. This could take the form of a physical delivery where the long buys the actual underlying asset from the short at the final settlement price or the form of a cash delivery where the net profit or loss is settled between the long and the short in cash.
Learn all about Futures Orders.