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Basics of Derivatives

Rollover

Here in this section, let us learn another common term called ‘Rollover,’ which is popularly used in the case of F&O trading. 

 

What is rollover? 

 

Rollover is carrying forward a particular month’s futures positions to the next month. This is done by closing the existing futures position of the current month and simultaneously taking a similar position in the subsequent series. 

 

Ideally, traders roll their positions in the last week of the expiry series, typically on the expiry day. 

 

On the expiry day, traders have an option: they can either let their position lapse or enter into a similar contract expiring at a future date. 

 

For example, if you are bullish on Nifty, you can rollover or carry forward the Nifty future position by closing your original position which is due to expire and simultaneously initiating a buying position for the subsequent month’s contract. This involves a cost i.e. difference between current series and next series prices. 

 

Why do traders Rollover in the futures market?

 

Rollover is an important action for most of the derivative market participants. 

 

  • When they expect the current trend to continue in the near future
  • They are not willing to book losses and are expecting the trend to reverse from the current situation.
  • Cash and carry and reverse cash and carry Arbitrageurs tend to rollover their positions to take advantage of the price differentials.

What is the cost associated with a Rollover? 

A rollover can give both positive and negative yield. 

 

Positive Rollover yield: A short seller in a contango market where the future price is quoting above the spot price will have a positive rollover cost as the next series contract will trade with a premium. The contract will be available to get rolled at a higher price vis-a-vis current series contract, yielding an incremental positive spread.

 

A trader with long positions in a backwardation market where the future price is quoting below the spot price will also have a positive rollover cost as the next series contract will trade with a discount. The contract will be available to get rolled at a lower price vis-a-vis current series contract, yielding an incremental positive spread.

 

Negative Rollover yield: A trader with a long position in contango market where the future price is quoting above the spot price will have a negative rollover cost as the next series contract will trade with a premium. The contract will be available to get rolled at a higher price vis-a-vis the current series contract, yielding a negative spread.

 

A short seller in a backwardation market where the future price is quoting below the spot price will also have a negative rollover cost as the next series contract will trade with a discount. The contract will be available to get rolled at a lower price vis-a-vis current series contract, yielding a negative spread.

 

How do we calculate the Rollover?

 

Rollover is often expressed in percentage terms.

 

Nifty future June rollover statistics can be calculated as:

 

 

How to interpret Rollover?  

Rollover is an indicator of traders' willingness to carry forward their existing bets on the market. But the standalone figures will not tell us in which direction traders have placed their bets. 

 

On most occasions, lower¬ than average Rollovers signal uncertainty as well as unwinding of current trend, while the higher rollovers signal conviction of the current view which can lead to a continuation of current trend. 

 

Hypothetically, if Rollover in Nifty futures from March series to April is at 70% and its past three-month average Rollover is 64%, it means that traders are more convinced with the current market trend by building more positions. 

 

However, at times, tracking Rollover trends based on just percentage terms can be misleading; it is always better to see it in terms of total contracts/shares getting rolled too. 

 

For instance, 70% Rollover may have taken place at a lower base of open interest—number of outstanding positions —while an average of 64% rolls would have happened at a relatively higher open interest base.

 

Therefore, analysing Rollovers purely on the basis of percentage terms can lead to faulty analysis, and hence trades should also track Rollovers in terms of total contracts rolled and also analyse Rollover trends on the basis of Rollover cost. Usually, high Rollover cost signals that the mood is upbeat in the market.

 

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Units 18/20