What happens if you hold a futures contract until expiration

Last Updated on 3 November, 2022 by Samuelsson

Futures trading provides a great opportunity to trade in a wide range of asset classes (at low trading cost) and offers significant leverage, which can scale up potential profits for small trading accounts. As a prospective or beginner future trader, you may be wondering what could happen if a futures contract is held till expiration.

When someone buys a futures contract and holds it till expiration, the contract will be settled according to the settlement parameters stated in the futures contract. Every futures contract typically specifies how the contract will be settled on expiration, which can either be with cash or by physical delivery. Most brokers will not force you to take delivery of the underlying asset. Instead, you will be brought out of the position automatically at a small fee.

There are other ways to play the futures market aside holding the contract till expiry. Keep reading to learn more.

How Futures Work

Futures are standardized contracts — normally trading on a futures exchange — for the delivery of a specified amount of a given asset on a future date, at an already agreed price. Depending on the underlying asset, futures contracts can be classified into commodity futures, equity index futures, single stock future, and volatility index futures.

Ordinarily, the parties in the contract (the buyer and the seller) will exchange the specified quantity of the underlying asset on the specified future date (expiration date). But not every futures trader wants to deal with asset delivery — most traders are in this solely for speculation.

What Happens If You Hold a Futures Contract Until Expiration?

Interestingly, there are several ways to manage a contract, making futures trading very flexible. When trading futures, you have three options for managing a contract:

  1. Offset your position
  2. Rollover your position
  3. Hold till expiration

Offset Your Position

You can offset your position before the expiration date. Offsetting or closing your position is a common method of exiting a trade. To close your position, you have to take an opposite and equal transaction to neutralize the trade.

For instance, if you’re long one WTI Crude Oil contract that expires in June, you will need to sell one WTI Crude Oil contract that expires on the same date to offset your position.

Rollover Your Position

If you want to continue holding the contract beyond the expiration date — without taking cash or physical delivery of the asset — you can rollover your position to another contract further in the future.

When rolling over a contract, you have to simultaneously offset your current position and open a new one in the next contract month.

Hold Till Expiration

If you hold the futures contract till expiration, the contract will have to go into a settlement. Depending on the type of underlying asset and the specifications of the contract, as the buyer, you may have to take delivery of the asset. Generally, there are two methods of settling an expired futures contract:

  • Cash settlement

    Futures Expiration

  • Physical delivery

Note that most brokers will not force you to take delivery of the underlying asset. Instead, you will be brought out of the position automatically at a small fee.

Cash Settlement

Some futures contracts are settled with cash after expiration. Generally speaking, equity index futures, single stock futures, volatility index futures, and other futures whose underlying assets cannot be physically delivered are settled with cash.

Commodity futures, on the other hand, are not usually cash-settled, but in nearly all cases, the exchanges provide a cash settlement option for them. In such situations, the exchange will often make the information available on their website. Furthermore, if a commodity futures contract is to be settled with cash on expiration, instead of physical delivery, it will be stated in the contract terms.

For contracts that can be cash settled on expiration, you may not need to offset your position earlier — though, you can closeout before the expiration date if the price is aggressively going against your position. Keep in mind that many brokers charge a fee if you stay in until settlement!

When the contract expires, the position is automatically closed. If the settlement price of the asset is higher than when your entry price, you have made a profit, but if it’s lower, you have made a loss. Whatever profit or loss realized is added to or subtracted from your account.

Physical Delivery

Futures contracts that are physically delivered require the parties to the contract to exchange the underlying asset on expiration. The futures exchange, where the trade is made, will often ensure that the seller delivers the product to the buyer.

Futures that are normally settled by physical delivery include commodities like corn, cotton, oil, and wheat. If a contract is to be settled by physical delivery, the terms of the contract will state so. However, only a small fraction of futures contracts are actually delivered.

Physically delivered contracts have a First Notice Day (FND) and the Last Trading Day (LTD). The FND is the first day the exchange can assign delivery to you (being the buyer), while the LTD is the last day the contract can trade. Delivery can be assigned every day, from the FND to the LTD.

What Happens If You Hold a Futures Contract Until Expiration?

Your broker should be able to notify you that your contract is settled by physical delivery when the FND is approaching. As said previously most brokers will liquidate the position for you at a small fee, which ensures that you don’t take delivery of the underlying asset.

What’s In a Futures Contract?

Futures contracts are standardized, and each contract will normally state the parameters of the contract, such as:

  • The currency in which the contract is quoted
  • How the contract will be settled — whether it’s with a cash settlement or by physically delivering the asset
  • The quantity of the asset to be delivered
  • The unit of measurement
  • What grade or quality of the asset to be delivered — the octane number of gasoline, for example, or the karat of gold
  • The currency unit in which the contract is denominated

Final words

Futures contracts held till expiration are settled with cash or by physical delivery, depending on the specifications of the contract. Most futures traders trade purely for speculation and try to avoid physical delivery by either closing their trades before the expiration date or rolling over their positions to next contracts further in the future.

 

Traders roll over futures contracts to switch from the front month contract that is close to expiration to another contract in a further-out month. Futures contracts have expiration dates as opposed to stocks that trade in perpetuity. They are rolled over to a different month to avoid the costs and obligations associated with settlement of the contracts. Futures contracts are most often settled by physical settlement or cash settlement.

Key Takeaways

  • Traders will roll over futures contracts that are about to expire to a longer-dated contract in order to maintain the same position following expiry.
  • The roll involves selling the front-month contract already held to buy a similar contract but with longer time to maturity.
  • Depending whether the futures is cash vs. physical settlement may influence the roll strategy.

Why Roll?

Rolling futures contracts refers to extending the expiration or maturity of a position forward by closing the initial contract and opening a new longer-term contract for the same underlying asset at the then-current market price. A roll enables a trader to maintain the same risk position beyond the initial expiration of the contract, since futures contracts have finite expiration dates. It is usually carried out shortly before expiration of the initial contract and requires that the gain or loss on the original contract be settled.

A futures position must be closed out either before the First Notice Day, in the case of physically delivered contracts, or before the Last Trading Day, in the case of cash-settled contracts. The contract is usually closed for cash, and the investor simultaneously enters into the same futures contract trade with a later expiry date.

For example, if a trader is long a crude oil future at $75 with a June expiry, they would close this trade before it expires and then enter into a new crude oil contract at the current market rate and that expires at a later date.

Physical Settlement

Non-financial commodities such as grains, livestock and precious metals most often use physical settlement. Upon expiration of the futures contract, the clearinghouse matches the holder of a long contract against the holder of a short position. The short position delivers the underlying asset to the long position. The holder of the long position must place the entire value of the contract with the clearinghouse to take delivery of the asset.

This is quite costly. For example, one contract of corn with 5,000 bushels costs $25,000 at $5.00 a bushel. In addition, there are delivery and storage expenses. Thus, most traders want to avoid physical delivery and roll their positions prior to expiration to avoid it.

Cash Settlement

Many financial futures contracts, such as the popular E-mini contracts, are cash settled upon expiration. This means on the last day of trading, the value of the contract is marked to market and the trader’s account is debited or credited depending on whether there is a profit or loss. Large traders usually roll their positions prior to expiration to maintain the same exposure to the market. Some traders may attempt to profit from pricing anomalies during these rollover periods.

Written by Jane