Saturday, November 11, 2006

Rolling Futures Contracts

Bill over at NoDooDahs was asking in a comments thread below about when it is prudent to roll your position from one contract to the next.

The basic answer is to know when the notice period starts (for physical delivery contracts) or to otherwise keep an eye on open interest and volume.

We have an example occuring at the moment in Cotton, and it helps to see the charts to see exactly what is happening. The 1st notice day for December delivery is November 22, as detailed at the NYBOT. So any speculative traders not intending to participate in delivery had better be out of the December contract by then. We can see in the charts that this is already occurring.

Open interest in the March contract has now overtaken OI in the Dec and for all intents and purposes, March is now the spot contract. Traders are either starting to roll out now, and/or initiating any new positions in the March contract instead.

For a trader, liquidity is paramount in avoiding slippage as much as possible, therefore you wouldn't want to let volume and OI dry up too much before rolling out. It's a judgement call that can be affected by when you anticipate exiting the trade. If an exit is imminent for whatever reason, you wouldn't want to be flipping contracts and incurring costs for no benefit.

If I was in a position trade in the Dec contract here, and anticipated holding the position for a bit longer, I would be looking to roll out at any time now. The exact timing is not usually of any consequence in this situation.

Interestingly, cash settled contracts OI behave the same way. Dec Lean Hogs, a cash settled contract, trade right up till the 14th of December (more than a month left to trade), yet the Feb contract now has higher OI (see charts here). Obviously a close eye on OI and volume is requires here also.


NO DooDahs said...

Take a look at NYMEX HH Nat Gas. Would you be rolling into Jan 07 or Mar 07 based on open interest? What role does volume play in the rollover decision?

Avalonian said...

Hi Bill,

It would depend on your time horizon. Obviously the shorter the time frame the more important volume is, particularly with a rapacious beast like NG.

Swing traders want to be in the most liquid contract, and that means the highest volume firstly, and enough OI to ensure continuity of that volume, second.

There is a lot of OI out in the march, but that will be mostly commercial hedgers, rather than speculators.

For me it would be the January contract. But if someone was initiating a trade that intended to be held more longer term, they might just go for a longer dated contract.

NO DooDahs said...

I'm looking at this from a possible mechanical long-term trend following system, in other words, the trades would be open-ended; if the technical behavior is A, sell, if B, hold, if C, add to position, and possibly roll over indefinitely.

Check out coffee, I knew back when the tsunami hit that it was a long-term play but didn't have any knowledge of how to play it with a futures contract. So I'm making it a project to start learning about futures in general.

OK, so if hedgers are taking OI in later months, then to trade/speculate from a trending position, one should most likely be in the current or subsequent contract only, correct?

Avalonian said...

I think that would be so, Bill. My guru (a CTA) trades mechanical trend following systems, and that is his policy also.

Re coffee

Yes getting interesting. There is some interplay between the Robusta (London) contract and the Arabica (NYBOT) contact. Problems in Vietnam apparently.

Avalonian said...

It's worth mentioning that unless there is some non-tranparent factor in play affecting one delivery month and not another, the setups in the spot and backs months will be nearly identical.

So it's a judgement call really.

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