How it works
Nobody pays the full value at the start. Each side puts down a deposit called margin, a fraction of the contract’s value. Every day the exchange settles the day’s gain or loss in cash between the two sides, and a side whose deposit has run low must add to it at once.
Every contract has an expiry date. On that date it is settled: by delivering the goods, for some contracts, or by a final cash payment for others. As expiry approaches, the contract’s price and the price for immediate delivery (the spot price) come together, since they are about to be the same thing.
Someone who wants to keep a position beyond expiry must roll: close the contract that is about to expire and open the next one. The two contracts rarely have the same price. The later one includes the cost of carrying the thing until then (interest, storage, insurance), less anything it earns in the meantime, and reflects how scarce it is today. When later contracts are priced higher the market is said to be in contango; when lower, in backwardation.
That gap is the cost or gain of rolling. If the spot price ends up unchanged, a later contract bought above it drifts down to meet it and the buyer loses the gap; one bought below it drifts up and the buyer gains the gap. For a seller it is the reverse. A position held for a long time through many rolls can therefore do noticeably better or worse than the spot price it was meant to follow.
What it costs
- A commission and exchange fee on each contract, paid again at every roll.
- The spread between buying and selling prices, crossed twice at each roll.
- The roll itself, when later contracts are priced above the spot price and the position is a bought one.
- The interest given up, or paid, on the money held as margin.
The risks
- Leverage: the deposit is a fraction of the contract’s value, so a small price move is a large gain or loss against the deposit.
- A loss can exceed the money deposited, and more must be paid in at short notice or the position is closed.
- A contract held into expiry may require delivery of the goods, or acceptance of them.
- Roll cost can wear away a long-held position even when the spot price goes nowhere.
- Prices can move by the exchange’s daily limit, or gap, leaving no chance to close at the price intended.
Where people go wrong
- Expecting a rolled futures position to follow the spot price. Over many rolls the two can part by a wide margin.
- Holding a contract too close to expiry without being able to make or take delivery. In April 2020 a United States crude oil contract settled at a price below zero on the day before it expired, as holders who could not take delivery paid to be released.
- Looking at the deposit and not at the full value of the contract, and so taking a position far larger than intended.
- Reading a higher price for a later contract as a forecast that the price will rise. Much of the gap is the cost of carrying the goods.
- Forgetting the dates. A futures position has a calendar, and it does not wait.
Questions people ask
- What does rolling a futures contract mean?
- Closing a contract that is about to expire and opening the same position in a later one, so that the position continues. The two contracts usually have different prices, and that difference is the cost or gain of the roll.
- What are contango and backwardation?
- Contango is when contracts for later dates are priced higher than nearer ones; backwardation is when they are priced lower. The gap mostly reflects the cost of holding the thing until the later date, less anything it earns, and how scarce it is now.
- Can a futures position lose more than the margin deposited?
- Yes. The margin is a deposit, not a limit. Gains and losses are settled on the full value of the contract every day, and if losses exceed the deposit the holder owes the difference.
The words on this page
A general explanation for study, with invented examples. Costs, taxes and rules differ by country, market and product, and the documents of the thing itself are what count. Educational information, not investment advice or a recommendation to trade.