What is Rollover & How Does it Work?
The two terms rollover and rollover percentage are rather common parlance when one is talking about futures contracts. A rollover is defined as the practice of carrying forward one’s future positions which are nearing the expiry date and opening the same position in a further-out month contract.
In other words, it is carrying forward the futures position from the current series to the next series. This could be done either at the mid-month or the far-month, which hinges upon the price of the rollover and the liquidity that is available. Equity derivatives in India are settled on the last Thursday of every month, and if Thursday happens to be a holiday, then the positions are settled a day before, that is, on Wednesday.
Futures traders need to determine whether they should let any of their existing positions close or carry it forward. ‘Carry it forward’ essentially means that the trader would enter into a similar contract at future dates.
Rollovers can be understood using an example for a long and short futures position. Assume that a market participant has bought 15 lots (long position) of PQR futures in the current month and expects a bullish trend to continue. So, the participant would initiate a rollover which would involve them selling the current lot at or near to the last Thursday of the month and buying the lot for the next month simultaneously. This would close the current month's position and open a new position of next month.
Similarly, assume a participant who must’ve sold 15 lots (short position) of PQR futures in the current month due to a bearish outlook and is expecting this trend to persist, then they would initiate a rollover by buying the current month’s contract on the last Thursday and selling the next month’s futures. This would also close the current month’s position and opens a new position of next month.
The rollover cost is paid or received by the participant who is initiating a rollover depending on the futures price and position.
As an example, let’s assume that an investor is holding a long position on Nifty 50 Futures on an expiry date of say 28th May, which means that this investor has the expectations of these futures to rally further in the upcoming month/months. To take advantage of this, the investor can liquidate their current month contract which is in the May series and get into a new long position in the June or July series depending upon how long the investor expects the uptrend to continue. On the other hand, if there is an expectation that the position will weaken further, then the investor will likely close the position.
How is Rollover calculated?
The rollover percentage can be expressed mathematically using the following formula:
Rollover percentage = (Combined Mid and Far month Open Interest/Total Open Interest across Series) * 100
The rollover percentage is an indication of what quantity of the Open Interest (OI) futures positions in the current month are being carried forward by the market participants to the next month. Open Interest indicates the number of contracts that are due or active in the market and are yet to be settled.
How to interpret the rollover percentage?
One of the salient features of interpreting rollover percentages is that there doesn’t exist any benchmark for rollovers, but their values are compared across each other using historical data, with the trailing three-month average being the most popular.
One thing which must be noted is that it cannot be determined whether the same market participants who had a position(s) in the previous month are the ones who have performed a rollover of their positions, or are they a completely new and distinct set of participants who have done so. All that the rollover percentage conveys as a metric is the sentiment in the market, with a rollover percentage which is lesser than average indicating a potentially uncertain outlook and a higher than average rollover percentage signalling a robust sentiment around the ongoing momentum to continue as before.
Rollover percentages, in isolation, may not be indicative as they would be once they are looked at along with a few more factors.
Comparison with historical rollover data:
As an example of considering the difference between current and previous rollover figures, assume that a future contract’s rollover in the Nifty Futures from the September 2021 series to the October 2021 series is measured at 81% and the three-month average is 67%. This is usually indicative of the fact that market participants are considerably convinced with their own views of the market direction, and consequently are willing to carry forward their futures positions to the next series.
But while making this conclusion, it should be noted that such trends may be misleading, due to the base on which these rollovers must have happened. As an example, let’s assume that 81% rollover has been calculated at a lower base of Open Interest as compared to the average rollover measured at 67%, which may have been calculated on a relatively higher Open Interest base. So, speaking from a historical context, it becomes important to consider the underlying base on which rollovers happen.
How to Calculate Rollover Cost in Futures?
Another important factor is the Rollover cost, which can be mathematically expressed as follows:
Rollover Cost = (Next Series Price- Current Series Price) / (Current Series Price) * 100
The basis at which the percentage or points of the futures positions are being carried ahead from the current series to the next series is conveyed by the value of the rollover cost.
Rollover cost should also be considered in unison with other factors. If one observes a high level of rollovers to the next series along with an increase in the cost of carry it can potentially signal a bullish outlook for the underlying stock or the index. Similarly, if one observes a high level of rollovers to the next series with a decrease in the cost of carry this can be a likely indication of there being a bearish outlook on the underlying stock or index. As an example, if the Nifty were to record a rollover of 83% from the future contracts of the current month series to the next month series along with an increase in the premium of Nifty Futures over Nifty Spot, then it is likely that it is a bullish indication for Nifty.
Rollover percentage and price-action of underlying:
The rollover percentage can also be analysed after bringing in the price-action of the underlying security of the futures contract. A high rollover percentage coupled with a positive price action in the underlying stock usually suggests that the robust movement will continue. On the other hand, a high rollover percentage along with negative price action would possibly be indicative of the current weakness to persist.
On similar lines, a relatively lower rollover percentage coupled with positive price action may indicate short covering and sign of trend reversal and lower rollover percentage with negative price action may indicate that long traders are covering their position and expecting a trend reversal.
So, the rollover data is rather important to participants invested in futures contracts. It helps them understand how willing the market happens to be to carry forward any previous expectations. Rollover data is usually publicly available on websites when the contract reaches near expiry. ICICIdirect also publishes rollover analysis monthly on the next day of expiry.
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