What is futures expiration?
The creation of futures contracts made a huge revolution in the stock market. Initially, the purpose of their creation was to provide a completely new financial relationship between the seller and the buyer.
Thanks to a futures contract, entrepreneurs could agree on future deliveries of products at a pre-fixed price by a certain date.
Such an innovation on the commodity exchange made it possible to make relations between the parties transparent, and the exchange at the same time acted as a guarantor of the execution of the contract.
Naturally, with the passage of time and the active development of the exchange, in parallel with deliverable futures (which are still present on the commodity exchange), so-called settlement futures appeared.
The main purpose of which is speculative trading, as well as hedging risks on the underlying asset. However, the only thing that these two different types of contracts still have in common is the expiration of futures.
If we talk about a delivery futures contract on a commodity exchange, it is on this day that the goods are delivered and paid for at a pre-agreed price.
It is worth understanding that the expiration of a settlement future, namely a speculative one, is somewhat different from a commodity one, namely, on a certain day, trading on the asset stops and the asset itself is withdrawn from the market.
That is why, in order to avoid automatic closure of transactions at a price that is unfavorable for the trader, you must clearly know the expiration date of the contract you have chosen.
Determining the expiration time of a futures contract
Expiration of futures contracts, as a rule, occurs four times a year, namely quarterly.
However, it is worth understanding that on different exchanges and depending on the futures itself, expiration may differ slightly.
That is why it is very important to learn how to read this information directly from the name of the futures contract.
As an example, we will look at the September futures contract for Brent oil, which can be traded at InstaForex.
So, when you add this asset, you can see this name #XBZU7. The first three letters #XBZ are responsible for the underlying asset, and in our case, Brent oil, while the remaining two letters indicate the month and year of expiration of the futures.
So, the penultimate letter F indicates the month January, G – February, H – March, J – April, K – May, M – June, N – July, Q – August, U – September, V – October, X – November, Z – December.
Thus, it is worth understanding that to mark the months in the futures contract, the first letters of the names of the months in English were taken. The last digit indicates the year of the contract, namely if 6 is 2016, 7 is 2017 and so on.
More detailed information on the exact expiration date of the futures can be easily found on the official website of the exchange on which you trade futures, or on your broker’s page in the section on contract specifications.
The impact of futures expiration on price movement
The price movement of a futures contract, as a derivative asset, is almost always identical to the movement of the price of the underlying asset, namely a stock, index, or any other security.
It is this feature of futures that traders use to hedge risks that arise during trading with the underlying asset.
However, in the last weeks before expiration, the price movements of the futures and the underlying asset begin to diverge, and the volatility itself slows down very much.
This is due to the fact that as expiration approaches, traders begin to fix their positions at a more favorable price and move on to the next futures for the same asset, but with a different expiration time.
This factor must be taken into account in your trading, since spread and correlation strategies at this moment can produce huge losses.
In conclusion, it is worth noting that any futures trader simply must know the expiration time of the contract, since market activity directly depends on it.
It is also worth understanding that at the time of expiration the transaction will be automatically closed by the broker at the market price, so failure to take this point into account may lead to unexpected losses.