Introduction to Futures Contracts
Futures contracts are derivative financial agreements to buy or sell a particular asset or security at a predetermined price and time, regardless of the current market price. A buyer or seller of such a contract is obligated to purchase or provide, respectively, the underlying asset at the expiration date.
These contracts allow for speculation on the direction of a security, commodity, or financial instrument by using leverage. Additionally, since they are usually standardized, they are at times employed to hedge the price movement of an underlying asset to curtail any losses that may result from unfavorable price changes. Overall, futures are available on many different types of assets, stock exchange indexes, commodities, and currencies.
What is a Rollover Adjustment?
Futures contracts nearing the front-month expiration are automatically rolled over to a far-month contract to maintain continuity of the position. Accordingly, adjustments are performed on the position and account to nullify the open position’s impact, given its rate (price) change for the new contract period. Simply put, if the new contract is trading at a higher price, Buy positions will receive a negative adjustment and Sell positions will receive a positive adjustment. Conversely, if the new contract trades at a lower price, Buy positions will receive a positive adjustment and Sell positions will receive a negative adjustment.
Rollover Adjustment Calculation EXAMPLE
Rates at Time of Rollover
- A client holds 1 futures contract of oil
- 1,000-barrel base units in 1 oil contract.
- Existing contract Buy rate = $40
- Existing contract Sell rate = $42
- New contract Buy rate = $44
- New contract Sell rate = $46
- Sell Rate Difference = [New contract Sell rate] – [Existing contract Sell rate]
- $46.00 – $42.00 = $4.00
- Buy Position Adjustment = – [Number of contracts] X [Number of base units in one contract] X [Sell rate difference]
- – 1 X 1,000 X 4 = –$4,000
The client will still maintain the same positions of 1 contract of oil futures, though an adjustment of -$4,000 will be added/subtracted to their account while still retaining the same equity.