You Don’t Have To Go Home, But You Can’t Stay Here

Don Dawson

The title of this article is from a country song about a guy sitting at a bar at closing time.  The bartender is telling him he does not have to go home, but the bar is closing and he must leave.  I will use this as my segue into discussing a Futures contract rollover.

Let’s describe some of the parallels between this song and trading a Futures contract near its expiration.  The guy sitting at a bar represents a trader with an open Futures contract either long, short or a Spread position. The bartender is the Futures Exchange telling the trader that they don’t care if they stay in this particular market, but they must leave the contract month they are trading in because it is about to expire.  Like the guy at the bar the trader has a couple of choices he can make:

  • Liquidate his current position and be flat the market (guy at bar goes home)
  • Liquidate his current position in the expiring contract month and initiate a new position in the same market, but another month in the contract cycles (guy at bar goes down the street to a bar that is open later)

Unlike trading in the Equity market, a Futures trader engages in trading a vehicle that has an expiration date.  We are actually trading a contract on a physical Commodity of some type.  We are not taking ownership when we enter the contract like an Equity trader would a Stock transaction.  Like any other contract you might enter into these have:

  • A First Trading Day (FTD) (effective first day you can actually trade the contract month)
  • A First Notice Day (FND) that allows a trader to notify the Futures Exchange that they have intentions of taking physical delivery of the Commodity itself
  • A Last Trading Day (LTD) on which the contract expires and trading will cease for that particular month and year

Very few speculators will have to deal with FTD’s because these are usually many months and sometimes years before the contract has enough liquidity (volume) to trade in.

All Futures market participants will have to deal with FND’s and LTD’s at some point in their trading journey.

The majority of Futures contracts have a physical delivery process.  To find out if the market you are trading has a physical delivery you must read the contract specifications on the Exchange website where the product is traded.  Not being aware of this could potentially cost you a lot of money or having your position liquidated by your broker without your knowledge.  Don’t forget when trading Futures contracts you are trading with a leverage account.  This means you only have to have about 10% of the entire Futures contract value in your account to trade it, this is called Margin or Performance Bond.  The other 90% of the value of that contract is still your responsibility.  Trading Futures means you can lose a lot more money than what is in your actual trading account.

As an example, the Corn market only requires margin of $2,363 as of this writing to trade one Futures contract of 5,000 bushels of Corn.  Each bushel currently is worth $4.30.  That means the value of that contract is $21,500, leaving the Future’s trader responsible for another $19,137.   How would a trader lose more money than they have in their account?  Here are just a few examples:

  • The Corn market goes Limit up or down against their position for multiple days
  • The trader is trading in a contract after FND and the Exchange assigns a delivery to them requiring the trader to come up with the full value of the contract and somewhere to put the Commodity
  • A very unusual event happens during the less liquid time of the trading session and the market skips over your stop

I tell you about this because it relates to getting out of contracts in a timely manner or else you could face some of the above issues.  Futures Brokers will do their best to keep their clients from losing more money than they have in their accounts.  But we cannot rely on them in case they get busy or distracted and overlook our positions.  In the end we are each responsible for our own successes and failures.

To keep from getting a Commodity assigned to you the Exchanges created FNDs.  Some FNDs come days before the contract actually expires and others come the day after the contract expires.  The ones that come prior to expiration are the ones you need to beware of.  Most brokerage firms will use pop up messages on your platform screen to advise you of FNDs, but not all do this and the ones that do will not always post notices for all Futures markets.

Prior to FNDs the Exchange does not mind having Speculators in that contract month.  They actually like it because Speculators provide liquidity for their larger Commercial customers.  What the Exchanges do not want is to have Speculators in the expiring contract too close to the last trading days.  On the LTD of a contract the Exchange wants to settle that contract and notify all of the Commercial traders the actual price they will get paid or will have to pay for that physical Commodity.  If the Exchange were to allow Speculators to remain in the market up to the last day there would be potential for defaults on contracts by under-capitalized Speculators, thereby delaying the actual contract settlement price on the LTD.  From FND to the LTD the only market participants in that expiring contract will be Commercial traders.

If you are holding a position in a Futures contract on FND and you wish to maintain that bullish or bearish position you will be required to rollover your position.  Your broker cannot do this for you without a power of attorney.  They can take you out of a position if they feel there is monetary risk to you or the brokerage firm, but they cannot legally put you in a new position.

Let’s say you were long March Corn and tomorrow is February 28th, FND for the March contract.  You feel like Corn will continue to go higher for several months.  Maybe you have been in this position for several weeks and you have amassed a sizeable profit.  By Close of Business (COB) of the FND you will have to liquidate your Long March Corn contract.  All of the profits you had will be placed in your trading account as closed out profits.  Now you will need to buy another contract of Corn to maintain your bullish view of this market.  The next month in the Corn cycle is May.  Once you have closed out your long March Corn contract you could buy a May Corn contract at the market.  Then set your new protective stop and profit target for this contract.  Or you could look for a Support/Demand level nearby the current price in the May contract and place a set and forget order to buy.  The prices are usually different from one contract month to the next, but fortunately all traders have to trade the new price just like you do.  This new long May Corn contract can be held until your profit objective is reached, your protective stop is hit or until April 30th which is FND for the May Corn contract.  At which time you will have to rollover again to another contract month if you wish to stay long the Corn market.

Some markets like the Energy sector have contract expirations every 20 trading days approximately.  Rolling over positions every 20 days could be more hassle than it is worth.  Plus for every rollover you do there are new commissions to pay per contract on the new positions.  To eliminate the frequency of rollovers longer term traders tend to trade in back months away from the nearby front month.  For example, Energy traders could focus on trading in the March, June, September and December contracts instead of every month of the year.  This way you can reduce your rollovers to 4 times per year instead of 12 times.  Grain traders usually like to trade in distant months as well so they are not involved with rollovers.  Unlike the Financial Futures the physical Commodity Futures have more volume in the back month contracts to provide sufficient liquidity.

In our Pro-Futures classes at Online Trading Academy we go over these rollover days in detail.  Remember that our charts and trading platforms will have to be rolled over with each Future’s contract expiration as well.  Some chart packages will automatically do this for our charts using certain symbols on un-adjusted continuous charts. The Energy sectors for example will rollover their contracts and charts 3 trading days before the LTD.  This means the volume will leave that contract month and move to the next contract month in the contract cycles.  As Speculators you will want to also get out of these less liquid contracts and begin trading in the more heavily liquid contracts.

To find the dates of FNDs and LTD’s you would look on the Futures Exchange website and read the contract specifications page. There are product calendars on that same page listing all contracts for the particular market.

“At one point in your life you either have the things you want or the reasons why you don’t.”  Andy Roddick

–      Don Dawson

This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results. Reprints allowed for private reading only, for all else, please obtain permission.