[Music]
greetings traders and welcome back to
another in depth with chris episode in
today's discussion we'll be covering
what happens if you hold a futures
contract all the way to expiration we're
going to cover all of the options that
we have at expiration as well as cover
why expiring contracts can impact the
market for the rest of us even if we
aren't holding our own contracts until
expiration all of that and more to come
but before we go any further please do
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now let's get going
in the trading world a lot of us dive in
to the trading aspect more so around the
technical and the physical execution
process
and we don't really take the time to
understand the full process behind a
futures contract that means a lot of
traders aren't aware of what an expiring
contract actually is they just try to
avoid it generally at all costs so the
first thing that we'll do is we'll
understand the mechanics or talk about
the mechanics so futures are derivatives
that give the buyer the right to buy an
underlying asset at a predetermined
price and an agreed upon future date the
underlying asset can be commodities like
corn oil wheat or financial instruments
like foreign exchange or stocks buying a
futures contract is what we call going
long meanwhile selling one or borrowing
it to sell more or correctly described
is going short
let's take an example here and try to
understand and imagine what a futures
contract process looks like if we were
to say that trader a was going long on a
futures contract covering 100 shares of
xyz that is 100 shares of the company
xyz and the future price he agreed upon
is going to be 100 for the sake of this
example the contract is set to expire
after
90 days 90 days and we'll put a d next
to it so we remember that
and if trader b goes ahead and sells
this contract to trader a remember
trader a wants what we're talking about
here a price of 100 for a contract
length of 90 days
after 90 days the price of xyz if it's
risen to say 105 dollars let's say price
has gone to 105 dollars well they've
already agreed upon the price of 100
so in this case trader a would be making
out here because he's getting it cheaper
than what it currently costs now
obviously it could go the other way
around and trader b the one that sold
the contract to him would benefit if
price went down or went and closed below
in that 90 day period below that 100
mark
so why do futures contracts have to
expire well they have an expiry date as
it's called which is the time at which
the contract needs to be settled because
there needs to be an end how else would
this contract work if we just said i'm
going to buy at 100
at whenever i want obviously there would
be no counterparty willing to engage in
that transaction so the expiry date is
going to be the agreed upon date at
which we will pay the agreed upon price
there are many ways a trader can close
out a contract we have three listed here
we can offset the position we can roll
over and we can go to settlement in the
case of offsetting the position the
trader would be entering into a new
contract opposite to the current
position
when we are settling the contract we are
simply closing the position out
and then we have the ability to roll
over the contract to a future date and
essentially keep it going
now if we dive into this a little bit
deeper let's talk about offsetting the
position
an offset position involves taking an
opposite position to the one that the
trader is currently exposed to so if the
trader is is holding a long position
then the offset position would be to go
short on a similar futures position
any loss incurred in the original
position is expected to be nullified by
a profit in the offset taken position
this is the most common way of exiting a
trade and it also ensures that the
trader does not have to take physical
delivery so in most trading environments
you'll find that traders are off setting
their position by simply closing it out
then we have the rollover the rollover
is just another function that traders
can use to maintain their position as
the contract approaches its expiry date
for the rollover to take place the
current contract needs to be offset and
the trader simultaneously seeks a new
contract at a forward date rollover is
actually a way of extending a contract
rather than terminating an existing one
and for a rollover to occur traders need
to monitor the volume of the existing
contract and the contract expires at a
date later than the actual future date
then we have settlement and settling a
futures contract involves terminating
the contract by clearing the payments
arising out of the position held unlike
like offsetting or rolling over the
settlement is done on the expiry date
the settlement of futures contracts can
be done through physical settlement or
cash settlement the major drawback of a
settlement is that a trader has to wait
until the expiry date to go ahead and
close out the position and since futures
contracts provide the flexibility to
roll over or offset before the
expiration date traders generally do not
prefer to wait until the expiration date
so this is a very rare occurrence in the
trading world the risk is particularly
high for someone who is short in the
contract because hypothetically this
trader would be exposed to unlimited
liability if the underlying asset price
kept rising
let's talk about the impact that the
expiration of these contracts have on
liquidity and volume because this is why
it matters to those of us that don't
even plan on holding until expiry so as
the expiry date approaches there could
be a rise in the volatility of price as
traders are looking to take advantage of
any imbalances arising out of the future
price and the expected spot price
if a trader is long on a stock he might
short futures on the same stock and
benefit from the two positions price
differences now just prior to the expiry
date the trader could look to square off
the short futures position to minimize
his loss by going long directly on the
stock this increases the volume traded
for the stock and it also increases the
liquidity in the counter
so as a result these contracts
themselves as they are expiring even if
we don't think about it directly they
are leading to changes in both liquidity
and volume
futures contracts have a specific date
on which the contract expires
generally the exchange fixes the day of
the month when the contract should
expire
typically it will happen on the third
friday of the expiration month but this
day can vary across different markets as
well as different products
this is corn futures that we have in
this box here and on the left hand
column you see that it says month it
shows the month and year that these
contracts will expire this is pulled
right off of the cme groups page if you
want to go find whatever it is that
you're interested in i strongly
recommend checking out the cme group
so in summary a trader's actions on or
before or just how they handle the
expiration of their contract
does impact how profitable or perhaps
not profitable they will be and as such
it's important to understand exactly
what our options are and what happens
around the expiration process the more
you know the better off you are best of
luck out there everybody happy trading
happy hunting i'll see you soon
[Applause]
you