This article will give you a better understanding of Futures Expiration and how it impacts the market. We shall first explain the entire process of futures expiry. Following that, we dive into why market volatility tends to increase on this day and how you can navigate through it safely.
Understanding Futures expiry
On September 25th, the first batch of futures contracts on Binance is set to expire. Below are the following contracts that will cease to exist:
Contract
Listing
Expiry
BTCUSD Quarterly 0925
June 11th
September 25th
ETHUSD Quarterly 0925
July 24th
September 25th
ADAUSD Quarterly 0925
July 20th
September 25th
LINKUSD Quarterly 0925
July 22nd
September 25th
Futures contracts have a limited lifespan, and they will expire based on their respective calendar cycle. For instance, our BTC Quarterly 0925 will expire on the stipulated date mentioned on the contract specifications - September 25th, 2020. This is known as the expiry date.
On Binance, COIN-margined quarterly contracts expire every quarter - March, June, September, and December. When the current front-month contract expires, the subsequent contract will replace it as the new front-month contract. For example, the current front-month is September contracts. Upon expiry, December contracts will be the new front-month.
When a contract expires, a process known as settlement begins. Settlement is a procedure managed by the exchange to close all open positions in an expiring contract. Traditionally, settlement comes in two primary forms:
Physical: Traders are required to either assume delivery or deliver a specified amount of the contract's underlying asset.
Financial: Traders' account balance is adjusted to reflect realized profits or losses at expiration.
On Binance, all contracts are financially settled, this means no exchange of the underlying crypto assets. Once the futures settle, the corresponding settlement PnL appears in your wallet balance.
On expiration day, all expired open positions will be settled at a price determined by the exchange, this is known as ‘Settlement Price’.
The settlement price will be calculated as the average of the price index every second over the last hour (between 7.00 and 08.00 UTC) before delivery. Upon settlement, a flat 0.015% fee will be charged. Do note that you are only allowed to close positions but not open any new position in 10 minutes before settlement.
What to do on expiration day?
Before expiration day, you have three options:
Close the position before expiry
Rollover from front month to a further-out contract
Let the contract expire and settle.
Most short-term traders exit their futures positions before the expiration day. This is to avoid unexpected volatility and the hassle of contract settlement.
Suppose a long-term position trader wants to maintain a futures position in the underlying product. In that case, the trader can place a trade in another futures contract with an expiry date that is further out. This is known as Rollover.
Rollover refers to the transition from an expiring front-month contract to another contract in a further-out month. They are rolled over to a different month to avoid the costs and obligations associated with the contracts' settlement.
How do traders rollover futures contracts?
To rollover a futures contract, one can simply sell their open position in the front-month contract and simultaneously buy another contract in a further-out month. For example, if you are long 10 contracts of BTCUSD September, you will sell 10 September contracts and buy 10 December contracts.
Traders will determine when to rollover by comparing volume and liquidity on the expiring contract and the further-out month contract. Typically, volume and liquidity on the expiring contract will decline as it approaches the expiration date. When volume and liquidity on the expiring contracts are significantly lower than the next further-out month, traders will rollover.
Although you may rollover on the expiration date itself, it is best advised to rollover a few days ahead of the expiry date. Low liquidity on expiration day may result in larger bid-ask spreads and lead to slippages.
How does expiration day impact liquidity and volume?
As a trader, you need to understand the impact of futures expiration as it will influence the outcome of your trades and exit strategy.
Specifically, you must know how liquidity and volume affects your trading operations in this period.
Liquidity impacts your ability to buy or sell an asset at a fair price. Liquidity is crucial in the futures market because the lack of it may result in slippages, which affects overall transaction costs. As such, traders tend to gravitate towards contracts or markets with high liquidity to trade as efficiently as possible.
As traders rollover to a new contract, liquidity in the expiring contract will decline substantially. This results in higher market volatility owing to the combination of low liquidity and increased trading activity in the futures market. Furthermore, profit-taking from short-term traders also creates more volatility during this period.
Consequently, this creates a spill-over effect to the underlying assets as futures markets under-go increased volatility in the run-ups to expiry. This also explains why derivative expiration dates are some of the most-watched market events due to its impact on asset prices. As such, traders and investors tend to exercise tighter risk management around periods of contract expirations.
Nonetheless, futures markets are essential vehicles to manage risks and enhance the market's liquidity. Therefore, long-term traders, investors, and miners must have ample options to hedge or manage these risks, which happens periodically in a year.
With Binance's quarterly contracts, users can better manage their positions and profit amidst market volatility when the expiration date is approaching.
Be ready for expiration!
Whether you’re a hedger or speculator, contract expiration and settlement can have significant impacts on your trading operation. Therefore, it is essential to understand the intricacies surrounding futures expiration and settlement. If you are going to trade futures, make sure you understand their contract specifications and your obligations.
