Using Spread Orders To Roll Forward
by Csaba Radnoty
Most futures contracts have a delivery mechanism that involves the exchange of physicals for cash.
Understandably, few traders want to deal with the delivery process. To liquidate positions nearing
delivery and to establish new ones, traders use spread rolls, a technique used when rolling forward to a
new contract month. Most speculators prefer trading futures contracts that have the greatest amount of
volume and open interest, which provide the greatest liquidity. Usually, it is the front month that meets
these qualifications. As the contract approaches its expiration date, the trading volume and open interest
begin to shift to another contract month. (Sometimes, this shift occurs near the first notice day or the last
trading day.) For example, Figures 1 and 2 are March 1991 corn and May 1991 corn. The bottom of each
chart displays the open interest and the daily volume for each contract. After December the March
contract has steadily declining open interest, while open interest for the May contract is increasing. The
daily volume for March delivery begins to subside in February when compared with January, while the
daily activity increases for the May contract. Most frequently, it is not the front month but the next
contract month that will reflect the greatest open interest, but not always. So, when rolling forward it is
important to monitor the volume and in particular the open interest to be certain one selects the
appropriate (that is, the most liquid) contract month.
The concern over liquidity arises because in an illiquid market it is almost impossible to obtain the price
you want. With few traders in the market, buyers will not necessarily come in at your sell price or,
conversely, sellers may not be available at your buying price, resulting in an unacceptable amount of
slippage in your trade.