Rolling over is the practice of closing an existing position in a derivative contract and simultaneously opening a new position in the same asset with a later expiration date.
Understanding the roll process
Elephants trading derivative contracts use instruments that have finite lifespans. As the expiration date approaches, traders must decide whether to settle the expiring contract or maintain their market exposure. To maintain exposure without taking physical delivery or cash settlement of the underlying asset, traders roll the position forward.
This process involves two simultaneous transactions. A trader holding a long position in an expiring contract sells that specific contract to close it out. Simultaneously, the trader buys a new contract for the same underlying asset that expires in a future month. Executing these trades together limits the risk of price gaps occurring between the exit and the entry.
The new contract generally trades at a different price than the expiring one. This price difference creates what is known as the roll yield. Depending on whether the broader market is in contango or backwardation, the roll yield is either positive or negative. Traders calculate these price differences to determine if maintaining the position remains mathematically viable over the extended timeframe.
Example
Imagine an Elephant holds a long position in five wheat futures contracts that expire in September. The Elephant expects global wheat prices to rise over the winter and wants to maintain this market exposure through the end of the year. The Elephant also wants to avoid taking physical delivery of the grain in September.
A few days before the September expiration, the Elephant executes a roll over. The Elephant sells the five September wheat contracts to close the current position. In the same transaction order, the Elephant buys five December wheat contracts. The financial exposure to wheat prices continues into the winter months, and the physical delivery process is avoided.