What Is To Roll Forward A Futures Position?
Rolling forward, also known as Roll Over, is one of three actions futures traders take to close out their existing futures position. The other actions being to "Offset" and "Reverse".
When you roll forward a futures position, you are closing off a near term, possibly expiring futures position, and simultaneously opening the same
number of contracts in a further expiration month. This is like extending the expiration of your existing futures position by rolling it on to a
further expiration month in order to stay invested in the same direction for a longer period of time.
For instance, if you own 1 contract of S&P500 E-Mini futures expiring in September and there is only a few more days left to September expiration. You decided to roll the position forward to the December expiration, so you go to your futures trading account and select to "Roll Forward" your existing position to December expiration. At the end of the rolling forward procedure, you are left with 1 contract of S&P500 E-Mini Futures expiring in December.
Why Roll Forward Instead Of Manually Closing And Opening New Positions?
So, what is the difference between manually offsetting your existing positions and then establishing new positions with longer expiration? Why should there be an additional function called "Roll Forward"?
The main objective of using the "Roll Forward" futures order is that the closing order of the existing futures position and the opening order of the new futures position is executed SIMULTANEOUSLY so that there is no time gap in between the two orders which may result in slippage. Slippage is slight loss of profit when the stock moved in between the closing and opening orders. Using the Roll Forward order ensures that there is no chance of slippage between the two orders.
Roll Forward and Roll Yield
One concept to be aware of when rolling futures contracts forward is "Roll Yield" or "Roll Return". Even if orders are executed simultaneously, a profit or loss could still occur when futures contracts expire and are being rolled forward due to backwardation or contango. A positive Roll Yield is when a profit results from rolling a futures contract forward and occurs when the price of a futures contract converges UPWARDS on the spot price in a backwardated futures market. A negative Roll Yield is when a loss results from rolling a futures contract forward and occurs when the price of a futures contract converges DOWNWARDS to the spot price in a contango futures market.
Read the full tutorial on Roll Yield.
Roll Forward and Normal / Inverted Market
Another concept in futures trading to be aware of when rolling futures contracts forward is whether the term structure for that particular underlying is a normal or an inverted market. In a normal futures market, prices of futures contracts gets progressively higher with longer maturities. This is the normal state of the futures market which is the result of carrying costs involved in holding the underlying asset for longer periods of time. In an inverted futures market, there is a benefit to owning the underlying asset now than later. An example of such conditions is when inventory level is low. This results in the price of futures contracts getting progressively lower with longer maturities.
When you roll forward a futures contract in a normal market, you are closing a cheaper futures contract for a more expensive one which lowers leverage and Return on Investment. However, when you roll forward a futures contract in an inverted market, you are closing a more expensive futures contract for a cheaper one which increases leverage and return on investment.
Roll Forward and Basis
Basis is the difference between futures price and spot price. Basis is positive when futures price is higher than spot price and negative when futures price is lower than spot price. Basis is usually positive in a normal market resulting in deleveraging when rolling forward and is usually negative in an inverted market resulting in more leverage. Read more about Basis.
When to Roll Forward Your Futures Position
Futures traders usually roll forward their existing futures positions at or near expiration when the price of the futures contract has fully converged with the spot price of the underlying asset. However, in order to maximize returns or minimize losses when rolling forward, you need to take into consideration whether the market is normal or inverted and whether it is in backwardation or contango. When the market is in contango and converging downwards toward the spot price, you might want to roll forward your existing futures position earlier before the full force of the convergence happens.
If you are a beginner who isn't experienced enough to deal with the issues of rolling futures contracts forward, you might want to get into futures contracts with longer maturities right from the start if you expect to hold a futures trading position for a significant length of time. This will prevent any unintended loss due to negative roll yields.