How do futures contracts roll over and why?

A futures contract has an expiration, and upon expiration there are costs and obligations associated with the settlement of the contract. The contract is settled one of two ways, either physical settlement or cash settlement.

If you are a hedger, or your business deals in the physical asset, then you probably would choose physical settlement, because you intended to acquire the underlying physical asset. But if you are a speculator, a trader, then you have no intention of taking delivery, you simply want to settle prior to expiration by either liquidating your position entirely, or swapping the current front-month contract with the next further out month contract so you can continue with your trade position.

This swap of the front month for the next further out month is called roll over.

There are all sorts of strategies that dictate the best time or condition to execute a roll over. These strategies are usually dependent upon market conditions, daily volume, open interest, or any other number of machinations that a trader might deem advantageous.

Most sophisticated trading platforms that support futures trading will allow you to specify a roll over strategy, and the roll over can be automated or simply provide notification to alert the trader when a roll over is warranted.

The process to execute a roll over is quite simple, you liquidate the current position, and then acquire the new position. This is usually done as a serial order. In other words, the acquisition is done immediately after the old position has been liquidated.

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