Rollovers and reverse positions are two important strategies used in futures and options. These strategies allow traders to manage their existing positions. These also help traders adapt to rapidly changing market conditions. In this blog, we will understand the rollover and reverse strategies in detail.
What is a Rollover Position?
A rollover refers to the process of closing an existing futures or options position while simultaneously opening a new position with a similar contract but a later expiration date.
Traders typically roll over their positions when their contract is nearing its expiration date and they wish to extend their exposure to the underlying asset.
Rolling over positions eliminate the obligation of physically delivering or receiving the underlying asset upon the expiration of the contract.
By rolling over, traders can maintain their market exposure without the need for physical settlement.
To roll over a futures position, traders close their current position by selling the expiring contract and simultaneously buying the next contract with a later expiration date. This process can be done in a single transaction, which is also known as a 'calendar spread'.
For options, rolling over involves closing the existing position by selling the expiring option and simultaneously buying a new option with a later expiration date.
Traders may choose to roll over options to extend their time horizon or adjust their strike price to adapt to changing market conditions.
For example, let's say a trader holds a long position in crude oil futures with a contract expiring in June. As the expiration date approaches, the trader wants to maintain his exposure to crude oil but avoids physical delivery. He will roll over his position by simultaneously closing his existing June contract and opening a new position in the July contract.
The trader sells his June crude oil futures contract at the prevailing market price and, at the same time, buys an equivalent number of July crude oil futures contracts.
By rolling over, the trader extends his exposure to crude oil without having to physically deliver or receive the commodity at expiration.
A reverse position refers to the act of closing existing futures or options positions and simultaneously taking the opposite position in the same contract.
Traders use reverse positions when they believe the market direction is about to change or when they want to hedge their existing positions.
In a reverse position, traders sell their long (buy) position and simultaneously establish a short (sell) position in the same contract.
This reverse position allows them to profit from a potential decline in the market or to protect against losses in their existing long position.
For options, a reverse position involves selling the existing long option and simultaneously buying a short option with the same strike price and expiration.
This strategy can be used to generate income by collecting the premium from the short option or to protect against potential losses from the existing long option.
For example, suppose a trader is holding a long position in call options on a stock, anticipating a rise in its price. Later, he learns about a potential decline in the stock's value.
In such a case, to protect his investment from potential losses or to profit from a downward move, the trader will establish a reverse position by simultaneously selling the same number of call options he holds.
The trader will sell his existing long-call options at the prevailing market price and, at the same time, establish a short position by selling an equivalent number of call options with the same strike price and expiration.
This reverse position allows the trader to profit from a potential decline in the stock's value or hedge against losses in their existing long-call options.