Let us assume that you are positive on Tata Steel due to a further up-tick in steel prices globally. As a result, you have bought March futures of Tata Steel and you intend to hold it till expiry. Before the expiry the stock moves up by Rs.20 but then your view is that stock price has the potential to go up further. What are the options in front of you? As a holder of a long position in futures there are 3 options in front of you as under..
You can opt to book profits in the March Tata Steel Futures by selling the futures of equivalent quantity and closing out your position. You can book your profits and take it away.
Alternatively, in cases where the liquidity in the futures market is very weak you can opt to just let your futures expire. On the settlement date (last Thursday of the month) the difference between the closing price and the purchase price will be automatically credited to your trading account.
As a third alternative, you can also opt to roll over your long futures into the April contract. Basically, you sell your March Tata Steel Futures and simultaneously buy April Tata Steel Futures. This called a long roll and entails a roll cost. We shall look at this roll cost in detail later
Understanding the concept of cost of long roll over..
Let us assume that your bought March Nifty Futures at a price of 10,386 on Feb 20th. As of the close on February 23rd the Nifty is quoting at 10,507. That means the Nifty will yield you a profit of 121 per unit of Nifty. Assuming the current Nifty lot size of 75 units, you are sitting on a notional profit of Rs.9,075 (121 x 75). If you are still positive on the upward movement of the Nifty you can also choose to roll over to the April month contract. Look at the chart below..
The Nifty futures contract chart above captures the Nifty futures price for March, April and May contracts. As we are aware, each of these contracts will expire on the last Thursday of the month. When we roll over the Nifty from March to April, there will be a roll cost involved. Here is how it will be calculated..
Nifty March - 10,507 | Nifty April – 10,540
When you do a long roll over from March to April, you effectively sell the March Nifty and buy the April Nifty. Since you are buying the April Nifty at a higher cost you will incur a cost. That cost is called the rollover cost. Here is how the rollover cost is calculated..
(April Nifty – March Nifty) / March Nifty
= (10,540 – 10,507) / 10,507
= 43 / 10,507 = 0.00409
In percentage terms, this can be expressed as 0.41%
How do we annualize this roll cost?
[(1 + R) 12 – 1)] = (1.0041)12 - 1
Annualized Roll Cost = 5.03%
The annualized roll cost normally corresponds to the risk-free rate of return and will vary with the volatility in the market. For example, in times of heightened volatility, the annualized roll cost can even go well above 12%.
Effectively, when you long roll the Nifty futures you will be incurring a roll cost of 5.03% annualized. Therefore when you are holding on to the position for a longer period of time you need to ensure that your returns on the long position cover the roll cost too.
Using the roll spread window to execute long rolls..
Long rolls are done by those who are long on futures. These may pertain to futures of the Nifty or of individual stock futures. The NSE trading terminal offers you the benefit of rolling over your long futures position by defining the spread at which you want to execute the trade. For example, if you are long on the futures then your primary intent will be to roll over at the lowest cost possible. In the above case the cost of rolling over the long Nifty is 0.41% or 41 basis points. That is where the roll window is useful in rolling over these positions. Remember, the roll spread is never static but even during the day the roll spreads can vary from.
When you are on the roll window, you just define the spread you are looking at. When you roll over your long future what matters is the spread and the actual price of execution is immaterial. Let us say you want to roll over your long futures at a spread of 30 basis points or 0.30%. Then you can define your rollover target cost as 30 basis points. The system will execute your long roll over only if the rollover is available at 30 basis points or lower, not otherwise. If the roll spread does not come down to 30 basis points then your long roll over will not be executed. You are at liberty to keep shifting your target roll spreads based on the market conditions.
In the past, rollovers had to be done manually. The introduction of roll window plus the use of algos has made the task substantially easier.
Share your Mobile Number with us and get started