What Can You Expect on Futures Expiration Day?
Bitcoin is expected to experience a swell of volatility as BTC derivative contracts worth over $8 billion are about to expire at the end of this week. With open interest for both BTC futures and options contracts at an all-time high, the upcoming expiration day could jolt Bitcoin back into action.
This article will give you a better understanding of futures contract expiration and how it impacts BTC value. 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
Futures contracts have a limited lifespan, and they will expire based on their respective calendar cycle. For instance, our BTC Quarterly 0625 will expire on the stipulated date mentioned on its contract specifications - June 25th, 2021. This is known as the expiry date.
On Binance, quarterly contracts expire on the following calendar cycle - March, June, September, and December. When the current front-month contract expires, the subsequent contract will replace it as the new front-month contract. Suppose 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, futures 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 P&L 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 settlement fee is charged the same as the taker fee for all positions settled on the expiry date. Do note that you are only allowed to close positions but not open any new position 10 minutes before settlement.
Understand Binance Futures settlement and delivery at our support and FAQ pages.
What can traders do on futures expiration dates?
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 Roll Over.
Roll over 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 roll over futures contracts?
To roll over 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 roll over 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 roll over 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 asset liquidity and volume?
As a trader, you must 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 affect 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 roll over to a new futures contract, the expiring contract’s liquidity will decline substantially, migrating to contracts in the further-out months. Consequently, bid-ask spreads in expiring contracts will widen, increasing transaction costs significantly. As such, traders with positions in expiration contracts are always encouraged to unwind their positions ahead of the event.
How does futures expiration affect Bitcoin prices?
How is Bitcoin value affected on expiration dates as compared to non-expiration dates/Fridays? Comparatively, expiration dates for large derivative markets such as stock options or commodity futures tend to drive more volume and volatility in their underlying assets as traders rebalance or unwind their positions.
The surge in trading activity on derivative contracts results in increased price volatility in both the derivatives market and its underlying asset. 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 derivative markets under-go increased volatility in the run-ups to expiry.
The following observation (from January 2018 to April 2020) studies Bitcoin’s historical performances leading up to past expiration dates.
As shown, the average daily-return for bitcoin on the day of expiration is significantly larger than non-expiry days/Fridays. Bitcoin’s mean return on expiration days is approximately 1.20%. In contrast, Bitcoin’s average daily-return is under 0.40% for non-expiration Fridays. Meanwhile, its average daily-return for all non-expiration days is under zero.
Another observation is that Bitcoin’s historical performances before and after expiration dates displayed a similar phenomenon. Bitcoin’s average 7-day return before expirations is slightly positive at 0.22%, while its average 7-day return after expiration is much stronger at 0.8%.
The above observations showed that expiration dates do have an impact on Bitcoin’s market value. Specifically, expiration dates tend to drive more volatility in Bitcoin’s price as traders reposition their portfolio and move their capital from one contract to another.
Given these observations, traders and investors must exercise tighter risk management around periods of contract expirations.
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.
Hedge your positions with Binance Bi-Quarterly contracts now!
Be ready for expiration dates!
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.