In this article, we’ll talk about the lifespan of a futures contract and how a limited contract cycle can affect trading.
If you trade Forex or stocks, you probably never came across the term “expiration”. But if you trade futures or other assets that have a limited lifespan, then you need to understand this concept.
Expiration is the day when the life of a futures contract ends. The expiration date is the final date on which the futures contract is valid. On this day the parties involved have to fulfill their end of the contract. Depending on the type of futures – cash-settled or physically delivered – either mutual cash settlement between the parties occurs, or the physical delivery of an underlying asset takes place. With regular futures contracts, if a trader wants to avoid the costs and obligations associated with the settlement, he needs to roll over his contract to the next month. To do that, the day before expiration, he needs to liquidate his open positions regardless of floating profit or losses in his account and reopen them for the new contract.
It seems rather complicated, especially taking into account the fact, that to open a new position, a trader has to pay the spread to his broker again. Doesn’t seem very fair either, huh.
Fortunately, AMarkets has a smart solution to this problem. It’s called spliced futures.
However, the process isn’t as simple as it may seem. The tricky part splicing two contracts together is that they rarely trade at the same prices. So, they don’t normally splice together smoothly. Imagine, you bought 1 lot of Brent crude at $100. Then, your contract expires and rolls over to the next month. This time, however, your contract costs $50. This $50 difference is not a result of the market situation. It’s merely a result of the transition from one month to another which creates a gap in the normal chart. To prevent this non-market gap from affecting your trading account balance, AMarkets adjusts the price of the instrument by the fixed number of swap points and adds the adjusted points to the Swap column in the trading terminal. The adjustment is made both when the contract price becomes lower (like in our example above) and higher after expiration. The result is entered with a plus or minus sign, respectively. So, the value may be both positive and negative.
This adjustment ensures a seamless splicing and a smooth transition between delivery months. Using spliced futures allows traders to switch to a new contract without the need to reopen their positions and pay the unnecessary spread fees.
To keep track of expiration dates, don’t forget to check out the Expiration calendar. It’s available on AMarkets’ website in the Trading section.
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